AFF Sentinel Vol.7#11

Ostensibly an effort to prevent a reoccurrence of 2008's financial meltdown, financial reform has predictably fallen prey to the usual liberal goal of preventing anything bad from ever happening again. Consequently, any business that offers financing to customers could conceivably come under regulations and auditing like a bank.

Senators are also contemplating outlawing "shorting" or betting against a rise in the markets (Goldman Sachs Memorial Shorting Prohibition) in certain cases, we presume just so investors would never "discover" that someone was betting against their optimistic long position and get their feelings hurt. These senators must cheer kids mothers who set up soccer games so that they don't keep score, preventing any kid's self-esteem from permanent damage.

Incredibly, the root core and continuing offenders in setting off the mortgage crisis and wrecking the general economy - Fannie Mae and Freddie Mac ($145 billion and counting absorbed so far) -- are totally ignored.

Little publicity has surrounded the bill's efforts to overhaul derivatives trading. But the proposed rule changes, instead of just dealing with the synthetic derivatives based on the mortgage market that were intimately involved with the meltdown, throws a wide enough loop to capture many Main Street companies that had nothing to do with the crash. The definition of "financial activities" by non-bank companies is so broad the government could decide that feedyards or feed and fertilizer dealers who offer financing to customers could end up falling under banking regulations and the Federal Reserve. In fact, many companies could see federal supervision regarding the investments their own companies make with their own capital. Main street businesses as well as big retailers and Fortune 500 companies have expressed opposition to such pervasive government regulation.

Many companies use various forms of derivatives to manage risk. These derivative contracts are negotiated on an individual basis and fully collateralized on a contract-by-contract basis. The new "reform" legislation would require nearly all derivatives to be traded on public exchanges, increasing costs and forcing standardization, reducing the usefulness or eliminating some contracts. Ironically, forcing derivatives onto public exchanges would actually increase risk and reduce offsetting collateral, as Mark J. Roe explained (Derivatives Clearinghouses Are No Magic Bullet," Wall Street Journal, 5/6/10). Trading on an exchange shifts more of the responsibility onto the exchange's trading processes, reducing incentive for concern about counterparty risk. And the exchange would put aside reserves for only a small percentage of the volume of trading to cover failures, as opposed to each privately negotiated contract, which is fully collateralized.

Also, Congress is discussing taking away derivative trading away from major investment banks, thereby removing major players from the market and significant profits for the big banks. If derivative contracts were suddenly forced onto public exchanges and big banks aced out, who would handle the large volume of business? Would it be a few large but less regulated hedge funds or would the business be lost to London?

Republicans have at least been able to remove one major disaster, for now. Originally, the bill included a $50 billion pool of money guaranteeing rescue to "too big to fail" institutions. It was to be financed by banks and non-financial institutions. But opponents said such a small fund, in a real crisis, would be entirely too small. Congress would almost certainly back it up with "government" money, putting taxpayers on the hook for big banks again. In fact, the legislation made specific provisions for tapping various sources of government funds for rescue, providing specific channels rather than the creative financing the Bush and Obama administrations made up to fund rescues.

The Main Street Industry Alliance, including such groups as the National Association of Manufacturers, U.S. Chamber, Industrial Energy Consumers of America, the Fertilizer Institute and the National Petrochemical & Refiners have protested inclusion of their members into financial regulations that could "have devastating ramifications on job creation, innovation and U.S. competitiveness." The Wall Street Journal noted that, "Many companies, including agricultural firms, use derivatives to hedge against economic risks, such as changes in interest rates." ("Deal May Affect Banks' Trading Desks," 4/26/10).

Could the government's bumbling attempts at "reform" end up taking away a source of financing for feedyard customers and farmers? Will government damage the markets by beginning a series of moves to eliminate "shorts" and "puts" in trading so that "longs" and "calls" will have no other side to the trade? The mixer grinds on.

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