AFR in the News: Derivatives Make a Worrisome Comeback

Five years ago, federally insured banks went on a derivatives-trading bash that nearly crippled the U.S. economy. They’re at it again, according to a new report from the Office of the Comptroller of the Currency.

OCC figures show $7.5 billion in derivatives revenue for the first quarter of 2013, up 7 percent from the corresponding period of 2012, and 72 percent from the previous quarter. “Demand for derivatives — contracts whose value is derived from stocks, bonds, loans and currencies — is growing as investors and corporations try to lock in low interest rates,” writes Danielle Douglas of the Washington Post (6/21/13). “But critics worry that there are too few rules to protect taxpayers from a market dominated by a handful of banks.”

“Four banks — JPMorgan Chase, Citigroup, Bank of America and Goldman Sachs — account for 93 percent of all the derivatives activity,” Douglas points out. “Thirty-eight banks began trading derivatives in the first three months of the year, bringing the total to 1,390…”

Kurt Wilhelm, director of the OCC’s Financial Markets Group, put a positive spin on the trend, attributing it to “strong client demand for risk-management products as investors increased their hedging and positioning against potential changes in monetary policy.” His soothing comment carried echoes of 2004, when Alan Greenspan praised the financial sector for its mastery of risk.

As the derivatives market revives, support for stronger regulation seems to be ebbing in some quarters. As the Post story notes: “A week ago, the comptroller granted banks two more years to move derivative trades into separate units that are walled off from the rest of the bank. The ‘swaps push-out’ rule bars those affiliates from accessing the Federal Reserve’s emergency-lending facilities or relying on federal deposit insurance. Critics view the delay as another blow to reform.

“’Regulators have to get serious about implementing this law,’ said Marcus Stanley, policy director of Americans for Financial Reform. “The derivatives market is dominated by insured banks,” which means taxpayers would be on the hook if they ran into trouble, he said.