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Harkin bill would put light on ‘financial weapons of mass destruction’

Iowa Sen. Tom Harkin has introduced legislation aimed at establishing stronger standards of openness, transparency and integrity in the trading of swaps and other over-the-counter financial derivatives that have helped bring the nation to the brink of the worst recession in decades.

Harkin, chairman of the Senate Agriculture Committee, announced the filing of the bill Thursday (Nov. 20). He called the legislation a critical step toward rebuilding and restoring confidence in the U.S. financial system, which has been battered by a continuous stream of bad news.

Some economists estimate the total face value of credit default swaps has skyrocketed to a total of $531 trillion or eight-and-a-half times the world GDP of $62 trillion. “This has created a very dangerous situation,” Harkin said in a telephone press conference. “Indeed, Warren Buffett has called derivatives ‘financial weapons of mass destruction.’”

Over the years, he said, the Commodity Futures Trading Commission and Congress have accommodated the swaps industry by allowing instruments that are essentially futures contracts to be privately negotiated without the safeguards provided through exchange trading.

In contrast, trading of financial futures on regulated futures markets subject to the oversight of the Commodity Futures Trading Commission has been a “net positive to the economy, has caused no stress to the financial system and has easily endured the collapse of one and the near-collapse of two firms that were very active in the markets,” Harkin quoted Chicago Mercantile Exchange Chairman Terrance Duffy as saying.

“The economic downturn in this country is forcing us to examine all contributing factors to the crisis in our financial markets,” Harkin said. “By restoring reasonable safeguards and regulation of swaps, including credit default swaps, along with all futures contracts, this legislation will go a long way toward ensuring confidence in the markets and reestablishing soundness and integrity.

“My bill will end the unregulated ‘casino capitalism’ that has turned the swaps industry into a ticking time bomb. And it will bring these transactions out into the sunlight where they can be monitored and appropriately regulated.”

The legislation, the Derivatives Trading Integrity Act, will bring more transparency and accountability into the marketplace, he said. Specifically, the bill amends the Commodity Exchange Act to eliminate the distinction between “excluded” and “exempt” commodities and regulated, exchange-traded commodities; futures contracts for all commodities would be treated the same.

In addition, the bill eliminates the statutory exclusion of swap transactions, and ends the CFTC’s authority to exempt such transactions from the general requirement that a contract for the purchase or sale of a commodity for future delivery can only trade on a regulated board of trade. In effect, this means that all futures contracts must trade on a designated contract market or a derivatives transaction execution facility.

Virtually all contracts now commonly referred to as swaps fall under the definition of futures contracts and function basically in the same manner as futures contracts, Harkin noted.

The House Agriculture Committee also appears to be considering legislation that would extend Commodity Futures Trading Commission oversight to credit default swaps and other financial derivatives. The committee held its second hearing on the issue in as many months Thursday.

“One thing we learned at October's hearing is that very few people know much about the credit default swaps market and even fewer people know the significant role they have played in the financial and credit crisis that has threatened the stability of our economy,” said House Ag Committee Chairman Collin Peterson, D-Minn.

“I think one of the things we can do right away to start opening up and cleaning up the swaps markets is to use the CFTC model of transparent and above-board central clearing process. At some point, our regulators and the next Congress will have to get to the root of the problem before it is too late and allow for some real oversight of these markets, to provide transparency and accountability for both buyers and sellers, and to reduce systemic risk.”

“I am encouraged we are collectively moving forward with establishing a clearing mechanism for credit default swaps,” said Rep. Bob Goodlatte, R-Va., the committee’s ranking member. “It will improve transparency and risk management, and will create a method for price discovery.”

The credit derivatives market has grown dramatically over the last 15 years. Financial institutions, some of whom have notably failed or been taken over by the government in recent months, including American International Group (AIG), Lehman Brothers, Bear Stearns, and Washington Mutual, have been the most frequent users of credit derivatives.

Harkin said he did not expect the Senate to take any action on his legislation until the next Congress, which begins in January. “I’m just laying my markers down so that senators can begin thinking about how they want to address this issue.”


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