As Congress returns from its spring recess this week, the Commodity Futures Trading Commission (CFTC) -- which is poised to gain new authority over the risky financial instruments known as derivatives -- remains without a permanent chair.
The controversy plaguing the White House's choice to lead the CFTC, Gary Gensler, began last month when Sen. Bernie Sanders of Vermont blocked a floor vote on the nomination and suggested Gensler was not the "independent leader" needed to "create a new culture in the financial marketplace." Gensler's biggest sin, for Sanders, was helping to pass the Commodity Futures Modernization Act (CFMA) of 2000, a bill that kept the derivatives market out of regulators' reach.
Gensler has offered a mea culpa to smooth his path to confirmation by vowing to steer the CFTC toward meaningful regulation of derivatives. Unfortunately, the political jockeying over his past has obscured the key question: What is the best way to regulate the sprawling derivatives market?
After retiring at age 39 from Goldman Sachs, the derivatives-mad firm that has profited nicely from the government's multiple financial bailouts, Gensler came to the Clinton Treasury Department. There he worked on CFMA, the bill that allowed the derivatives market to metastasize into a hotbed of financial risk with an estimated value -- before last fall's financial crash -- exceeding the world's real financial holdings.
Derivatives are essentially contracts based on changes in the value of any asset, whether real (the price of soybeans) or more theoretical (the possible future losses any company suffers). Some derivatives are traded on regulated exchanges, but the CFMA gave the government's blessing to the so-called "over the counter" derivatives market, where handshake deals fly back and forth between financial parties with little or no regulatory oversight.
Gensler remained close to Wall Street players even after leaving the public sphere in 2000. He is a longtime investor in New Mountain Capital, a private buyout firm that paid him $70,000 last year in exchange for service on its advisory board. New Mountain, whose chief executive officer, Steven Klinsky, co-hosted a $28,500-per-head fundraiser for John McCain last year, even placed Gensler on the board of Strayer Education after taking it over eight years ago.
Such coziness with the financial elite could be radioactive for the Obama administration in the aftermath of the American International Group bonus flap and continued public frustration with the bailouts. But few on the Hill expect the hold to derail Gensler's nomination entirely.
"I know they're going to proceed," said Tyson Slocum, who has followed the derivatives market for years as the director of Public Citizen's energy program. "The question is exactly when, and what extractions will Sanders receive in exchange [for releasing the hold]."
Indeed, the White House is reportedly negotiating with Sanders to ease the delay, and a Senate Democratic aide said that the timing for possible consideration of the nomination is pending those discussions. A Sanders spokesperson, while declining to discuss what it might take to release Gensler, said the last significant contact from the White House had come before the two-week congressional recess.
But even if resistance to Gensler's nomination fizzles, Congress is taking the first steps toward bringing over-the-counter derivatives under the CFTC's aegis. Senate Agriculture Committee Chair Tom Harkin of Iowa introduced a bill late last year that would push all derivatives onto CFTC-regulated futures exchanges.
House Agriculture Committee Chair Collin Peterson of Minnesota went slightly less far with a measure that would require derivatives trades to be registered through a CFTC-approved body, a process called "clearing." Yet it is that seemingly arcane distinction -- between public, exchange-listed derivatives and those processed through a central "clearinghouse," often privately controlled -- that could prove the flashpoint for the next great regulatory battle.
Michael Greenberger, the University of Maryland law professor who headed the CFTC's trading division during the 1990s, told Peterson's panel in February that derivatives trading on exchanges is a superior alternative to clearing. Exchanges, he told the agriculture panel, are the best way to enforce safeguards against the fraud and manipulation that derivative traders were allowed to sidestep under the CFMA.
"We would never settle for clearing, and clearing alone, as a substitute for the regulatory and self-regulatory structure that surrounds the equities market," Greenberger said. "Moreover, clearing without other prudential safeguards just places an apparently sound financial institution as the guarantor of the counterparties [to any derivatives contract]."
University of Missouri professor William Black, the former senior bank regulator who helped wind down financial institutions that failed during the 1980s savings-and-loan debacle, agreed that clearinghouses are an insufficient method to keep tabs on destructive derivatives.
"You should have clearinghouses, but that wouldn't have stopped this crisis," Black said. "It would have blown right through the clearinghouses."
The financial-services industry is making no bones about what it wants to see: clearinghouses, not mandatory exchange trades. Clearinghouses for credit-default swaps, the type of derivative that helped bring down AIG, are already competing with each other to attract traders seeking private guarantees for their derivatives deals.
But where does Gensler stand on the issue? With Treasury Secretary Timothy Geithner, it seems. Both have called for derivatives to shift into clearinghouses and onto exchanges, saying little about whether industry or regulators would make the ultimate choice between the two options.
"I believe that we need to bring standardized products into mandated centralized clearinghouses and onto exchanges, establish a regulatory framework for derivatives dealers, and formulate appropriate oversight for credit default swaps," Gensler said in a Jan. 26 letter to Sen. Carl Levin of Michigan, whose investigations subcommittee has looked at the rapid growth in the unchecked market for energy derivatives.
Yet if derivatives traders are allowed to decide whether to route their work through private-sector clearinghouses or a more heavily regulated exchange, it's tough to envision many choosing the latter.
In that same letter to Levin, Gensler also defended himself from charges of complicity in the conscious deregulation of financial markets during the twilight of the Clinton era. "I believe that both our financial system and our regulatory structure failed the American people," the repentant nominee wrote, adding that he was advised to recuse himself during the 1998 tussle over derivatives that pushed Brooksley Born from her chairmanship of the CFTC.
Gensler will have a chance to back up his contrition with reform once he arrives at the CFTC. But in a capital where attention spans grow shorter by the day, who will keep shining a spotlight on the battle over reining in over-the-counter derivatives? Consumer advocates such as Slocum of Public Citizen are already adjusting their expectations.
"I'm not concerned that Gary Gensler is going to be bending over backwards to accommodate the needs of Goldman Sachs as chairman of the CFTC," Slocum said. "I don't think he's going to be a Ralph Nader, but I don't think Obama was going to nominate a Ralph Nader type. … When he said 'change,' he was not saying, 'change from corporate control of government.'"
