We Need Answers On Financial Reform

Daniel Dicker from The Street says we need more specifics about financial reform. With financial reform seeming to have fallen behind health care as the top priority of the Obama administration, Dicker fears that we may be missing an opportunity to regulate potentially harmful financial instruments. See the following post from The Street for more on this.

In the wake of President Obama's speech Monday, one piece of possible finance reform less explored is with derivatives, including credit default swaps, commodities and other over-the-counter issues. Despite the president's inspired speech preaching responsibility on Wall Street, we really haven't come very far in this area in the year since the demise of Lehman Brothers.

Part of the problem I had with his impassioned speech was with the lack of specifics. Despite being a great supporter of the president and having voted for him, I find many of his speeches great oratory events with little substance contained in them.

In his talk of finance reform, Obama made some vague calls for increased capital requirements for the big banks, a requirement that in and of itself wouldn't have prevented the cataclysm we experienced last year.

As to the most important ideas of transparency in markets, Obama focused on the idea of a "consumer czar" or other advocate in Washington who would somehow prevent the sale of mortgages that people couldn't understand or afford. How this would be done, however, remains a mystery.

But derivatives, which clearly exacerbated the financial downturn last year, were left conspicuously out of the president's speech. This is an interesting omission because they had gotten so much interest in their operation and their reform last year, but now seem to be on a very far back burner and not gaining much attention anymore.

This is a shame because I believe that derivatives, much more than shady mortgage practices, create a far greater threat to our financial health going forward.

What's interesting is that the Bush administration had taken the greatest strides in bringing transparency to this market, and the Obama administration, while having public sentiment and great momentum on their side, has really dropped the ball here and squandered a great opportunity.

It was former Treasury Secretary Henry Paulson who issued the ultimatum for transparency in credit default swaps, requiring a clearinghouse structure for clearing of these instruments. But since President Obama was inaugurated, Treasury Secretary Tim Geithner has done nothing to follow up on these initiatives, essentially leaving the market exactly as it was and leaving us open again for another "AIG(AIG Quote)-like" problem.

To the detriment of our economy, especially consumers, oil and other commodity markets have continued to show increased and unceasing volatility. They are being moved by investment capital, hedge funds, uncontrolled ETFs and just about everything except the fundamentals.

Despite our new president's impressive speeches, absolutely nothing has been proposed or undertaken to get a better handle on the roiling commodity markets.

And those markets are just a microcosm of the rest of the enormous over-the-counter markets of specialized and non-standardized forwards and swaps.

While the CDS market with its $26 trillion notional value has been the most visible of the OTC markets because of the trouble they've caused, other markets traded in the shadows of the investment banks pose as much or more of the same kind of risks in the future. In getting a handle on credit default swaps, a model for dealing with systemic risk in all of the OTC markets might be found.

You won't find enthusiasm from the biggest investment banks like Goldman Sachs(GS Quote), Morgan Stanley(MS Quote), UBS(UBS Quote), JPMorgan Chase(JPM Quote) and others, who derive terrific percentages of their profits from OTC trading for reform in these markets, many of which they created.

And other open exchanges that would benefit from transparency in the trading of CDS issues and other OTC swaps like the Chicago Mercantile Exchange(CME Quote), IntercontinentalExchange(ICE Quote) and the NYSE Euronext(NYX Quote) are less apt to push hard for reform because their biggest potential clients in these new markets are those same investment banks. You can't bite the hand that ultimately feeds you.

Good results from the stimulus package, bank bailouts and Fed guarantees of mortgages that halted the stock market slide and a total seizure of the credit markets have also stemmed the interest of market reform that got us into this mess in the first place.

This is a dangerous, if perfectly understandable reaction. Nobody ever thinks of fixing a hole in the ceiling more desperately than when it's raining. But when the rain stops and water isn't dripping on your head, that hole seems far less important to fix.

And Obama may be even less able to tackle these problems than his predecessor, despite his greater natural ease towards reform. The current administration has taken on quite a few issues at once and while the economy was clearly job one immediately after inauguration, it now feels as if it has taken a back seat to health care reform. One visit to Federal Hall yesterday on Wall Street and one speech, no matter how rousing, can change the amount of political capital that any president has and where he spends it first.

So a year after the fall of Lehman, it seems that we are nowhere closer to reforming or even creating new rules for the markets that were the source of all the difficulties last year -- including credit default swaps, commodities and other OTC markets.

I think we will live to regret having missed this opportunity.

This article has been republished from The Street.