May 18, 2009
Everyone is aware that today’s current financial system is problematic and the Obama administration is now trying to do something about it. Last Wednesday, the government sought to gain more authority over the financial instrument referred to as derivatives. These derivatives played a significant role in the collapse of the financial market following the huge drop in home prices.
Trying to right the wrong, the administration has encouraged Congress to pass on a legislation that will permit federal oversight on the previously deregulated industry. It will enable the government to oversee various types of instruments including the credit-default swap which nearly caused American International Group (AIG) to collapse until the government bailout.
Treasury Secretary Timothy Geithner said the proposal will require derivatives to be traded on clearinghouses that are backed by capital reserves. This works similar to the capital cushions banks are required to have for when a borrower can’t make good on a loan. These, along with the new rules will be most costly for all parties including the dealers, the buyers, and the issuers. Despite its expensive price tag though, this move will force a majority of derivatives to be traded out in the open. This reduces the role of the banking system that has surrounded them in the past.
According to Geithner, the “financial crisis was caused in large part by significant gaps in the oversight of the markets”, the proposal aims to clean up the system. If it pushes through, the trading of derivatives will become more transparent. Regulators will also be authorized to limit the number of derivatives an institution is allowed to sell or hold.
In addition, the Obama administration wants to repeal important portions of the Commodity Futures Modernization Act which was implemented in the December of 2000. Previously, it was backed by Democrats and Republicans alike with heavy lobbying from Wall Street.
Fortunately, the proposed change is well-received in Congress, for the Democrats in particular. The move has long been expected. In fact, experts in the financial industry even say that it is inevitable because everyone understands that changes need to happen. Steven Elmendorf said that “the only question is how the change happens.” From the looks of things, it seems like everyone is about to find out.
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