The US economy continues to have a hard time recovering from the biggest
financial crisis since the Great Depression. So, the last thing one
would expect the US government to do is to engage in policies that open
the floodgates to severe risks in financial markets once again. And yet,
that is precisely what’s going on.
For all the attention that is
paid to the Federal Reserve’s “tapering”, what Washington has in its
crosshairs is something quite different. It is putting massive pressure
on the Commodity Futures Trading Commission (CFTC) and the Security and
Exchange Commission (SEC). Unless concerned policymakers act quickly to
counter that pressure, the disastrous past — a financial industry
running amok — may well be not just the United States’ national, but our
common global future.
How is this even possible? Even though the
US Congress passed the Dodd-Frank financial reform law a few years ago
as a bulwark against reoccurring financial crises, the legislation
actually left most of the key decisions — the actual detailed
rule-making to rein in the financial industry — for later.
center of this entire issue is Gary Gensler, a former Goldman Sachs
partner, who is now the Commodity Futures Trading Commission Chairman.
Gensler is one of the few officials who can credibly say that, having
worked in the lion’s den for many years, he is committed to rectifying
what he knows is truly troublesome in the boiler rooms of the American
And yet, the deck is stacked against him. The
fundamental imbalance at the heart of this issue is not just very
irritating, but also profoundly undemocratic. Just look at the numbers.
The Sunlight Foundation found in a study released last year, that Wall
Street has met 1,298 times with government officials to influence the
new rules. In sharp contrast, public interest groups have only been able
to get 242 such meetings. Talking about being outgunned — by a factor
But this unsettling imbalance in the US political process
has consequences way beyond US borders. Not only is the US financial
industry still in a dominant position globally, setting many of the
standards and practices for “what goes”. The G-20 and the Financial
Stability Board also pledged that powerful nations like the United
States would see to it that the global impacts of their national
rule-making would be taken into account.
But now the United
States may blow a hole in the Dodd-Frank law that would allow many of
the key global operations of US banks to be entirely exempted from
The first blow came late last year. Very quietly,
when the US Congress was on its Thanksgiving holiday, the US Treasury
Department exempted foreign exchange (FX) swaps and forwards from the
Why should the American and global public care about
this? After all, when US banks operating offshore, and in places like
South Korea, sell FX derivatives to exporters, it allows them to hedge
against foreign exchange risk. That sounds innocuous enough.
when the last financial crisis hit there was such a flight of capital
out of emerging markets and back to the United States that many of those
positions were rapidly unwound. Such are the massive transmission
effects of today’s tightly integrated financial markets.
relenting, these same FX derivatives market operators got very busy
again right in the wake of the global financial crisis. Hedge funds and
big banks engaged in the carry trade. They borrowed in dollars at very
low interest rates and then invested in foreign currencies in a broad
range of countries, from South Korea, Brazil, Chile, Colombia, Mexico,
South Africa, Indonesia, to Thailand. Financial pros that as they are,
they then built FX derivatives that shorted the dollar and went long on
This fueled exchange rate appreciation and
asset bubbles that are part of the reason for the slowdown in emerging
markets. Now that the Federal Reserve looking to wind down its easing
policies, capital is fleeing emerging markets, causing exchange rates to
depreciate and debt burdens to rise.
By now, it is a familiar
story. Financial engineers, largely by US-owned firms, generate serious
blowback in the real economy. And get hurt themselves. Citigroup, a too
big to fail bank, may lose US$7 billion in FX derivatives markets if the
US dollar appreciates as capital flies back to the United States.
next regulatory blow may hit any day. The CFTC and the SEC are now
considering exempting those same foreign subsidiaries and branches of
hedge funds and big banks headquartered or with stakes in the United
States that have been packaging derivatives overseas.
be disastrous for emerging market and developing countries attempting to
maintain financial stability for development. To their credit, South
Korea and Brazil both have put in place their own regulations on FX
derivatives, but emerging markets alone cannot carry the burden of
regulating a $4 trillion per day market.
CFTC chair Gary Gensler
has said that, if these regulations are swapped out of the rule-making,
hedge funds can evade the rules “by setting up shop in an offshore
locale, even if it’s not much more than a tropical island P.O. Box”.
Gensler needs a majority of commissioners to help him close this
loophole by July 12. Time is running out. The world cannot afford to
create major loopholes that could threaten the global financial system
The writer is co-director of Boston University’s
Global Economic Governance Initiative and co-chair of the Pardee Task
Force For Regulating Global Capital Flows and Development.
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