From the April 01, 2010 issue of Futures Magazine • Subscribe!

Blame Mrs. O'Leary, not the cow

I admit I had never seen new Commodity Futures Trading Commission (CFTC) Chairman Gary Gensler speak before an audience. It isn’t because he’s been shy: since he joined the CFTC last year he has stormed through trading-related organization meetings giving speeches, reminiscent to Sherman’s army. And as the opening keynote at the Futures Industry Association’s (FIA) annual meeting in Boca Raton, Fla., Gensler did not disappoint. I was expecting an arid presentation in Ben Stein mode, but it was not to be. Gensler was lively and witty. He stood firm on his conviction to regulate the OTC markets, equating what these instruments did to our financial system to what Mrs. O’Leary’s cow did to Chicago in the Great Fire. He shared barbs with John Damgard, the FIA president who is renown for his humor, answered questions from a somewhat hostile audience straightforwardly and even commended them for how they weathered the financial crisis. “While no TARP money was used to cover market exposures on cleared futures transactions, AIG had to be bailed out in part to cover uncollateralized and uncleared derivatives contracts,” he said in his speech.

This speech wasn’t breaking news. He has used the Chicago fire metaphor before, stating that the result was stronger building codes. And he’s said repeatedly that the multi-trillion dollar OTC market remains largely unregulated and the most important parts of financial regulation must include that largely “standardized” OTC derivatives be centrally cleared and that dealers be regulated. Gensler stated “In some cases, even when a dealer may have been part of the larger regulated financial institution, its derivatives business was not explicitly regulated.” AIG’s financial derivatives group is a good example. Gensler believes requiring those groups to have sufficient capital, post collateral on transactions and be “subject to stringent record-keeping requirements” would prevent the out-of-control trading on the other 20-25% non-standardized OTC derivatives.

Of course he brought up the whole “transparency” issue, but I’ve become cynical of this push, especially as hedge funds are no more “transparent” today than they were after Long-Term Capital Management or Amaranth. And surely there are rules and regulations in place that require that a company must be diligent in its oversight. AIG’s derivatives unit was making insanely large profits to the dismay of other units within the firm that weren’t living up to the bewitched corporate heads. Haven’t we seen this before in Barings, or a better example, Enron? High returns typically mean high risk is taking place. So what the hell were the overseers of AIG doing? Lehman Brothers is another example of Wall Street leadership largesse: according to the court-appointed examiner, allegedly Lehman chief Richard Fuld goosed the financial statements to show better results.

Although I applaud Gensler’s somewhat reasoned approach to regulate a large, unwieldy and highly lobbied group, especially when it’s a world he came from (Goldman Sachs), I’m still dubious. Seems to me the “smartest guys in the room” were doing their job: making money for the company. If they were committing fraud, they should go to jail. Period. But for Congress to work around the system to make it look like something is being done is flawed. The focus should be on the top executives and boards who were collecting checks while looking the other way. To use Gensler’s metaphor, ignoring the leadership oversight issue would be like new building codes that demand brick structures be built, but turn a blind eye to the inspectors who ignore poor wiring because they get a piece of the action.

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