WASHINGTON -- The top Republican on the House Banking Committee yesterday called for federal constraints on derivatives activities and criticized the Treasury's plan to consolidate the banking agencies, saying it would politicize bank regulation.
While allowing the derivatives industry to regulate itself might have been possible once, "the quantum growth in derivatives trading has changes the nature of the market and the public relationship to it" so much that "prudential restraints must be established before improvidential acts occur," Rep. Jim Leach, R-Iowa, told those attending a banking conference here.
Leach said that "it is imperative" that federal regulators establish guidelines to limit active participation in the derivatives markets to "institutions with solid capital and solid management." He also said that derivatives products that are not federally regulated must be subjected to federal regulation.
In his speech, Leach said the multitrillion dollar derivatives activities of the 10 largest commercial banks in the U.S. is about double the annual gross national product of the nation.
"If this doesn't define a pyramidal house of cards -- particularly in the event of a market shock sparked abroad by warmongers or at home by private sector speculators or public pandering protectionists -- what does," Leach asked.
While industry officials and federal regulators have touted the importance of derivatives to manage risks, Leach said "it is simply not true that all aspects of the derivatives business are risk-free, that all derivatives trading is unspeculative in nature and that all trading has a clear-cut defensible social purpose."
Leach worried that traders at federally insured banks dealing in derivatives are earning huge commissions for "privatizing individual gain but leaving risk to be absorbed" first by the shareholders of the banks and ultimately by the public through the deposit insurance safety net.
He even suggested that the newly strengthened deposit insurance fund "may gain be in jeopardy" because of the "uncertainties surrounding potential abuse of the derivatives market."
Several public agencies are at risk if derivatives activities lead to serious losses, Leach said.
"The allure of quick derivatives profits to underfunded pension funds, overstretched banks, or under-regulated insurance companies must become a matter of concern," he said, adding that if a pension fund fails, the Pension Benefit Guaranty Corp. loses; if a bank fails, the Federal Deposit Insurance Corp. is at risk; and if an insurance agency fails, state agencies could be affected.
Leach worried that as the derivatives market continues to expand to smaller players, larger, more sophisticated institutions will be in a position to take advantage of them.
He said he is also concerned that even though derevatives allow financial managers to reduce risks, they can also increase volatility in the market. Certain derivatives products such as those based on exchange rates, for example, "induce extended swings in the market which self-servingly makes use of such products more important for commercial firms, but more dangerous for the taxpayer bystander," Leach said.
Leach worried taht if there is a "tremor" or disruption in the market, derivatives may "quantumly increase risk for the [financial] system as a whole."
Leach announced recently that he is drafting a bill that would createan interagency commission to establish comparable standards for derivative products and to be accountable for oversight of the derivatives market.
In his written speech, he said it might be appropriate for the commission to have regulatory authority over exchange-traded derivatives instruments.
Meanwhile, Leach said he has "grave reservations" about the Clinton proposal to consolidate federal banking agencies that was announced by Treasury officials recently. The proposal calls for a new federal banking commission that assumes the regulatory and supervisory powers currently held by the Federal Reserve, the Office of the Comptroller of the Currency, the Office of Thrift Supervision, and the Federal Deposit Insurance Corp. The five-member commission would include Treasury and Federal Reserve officials as well as three members appointed by the President.
But Leach blasted the proposal, saying it would "presidentialize" authority over bank regulation and "[raise] the coercive specter of presidential money managers a la Maurice Stans demanding political contributions from large institutions with the implication that regulatory decisions could be affected -- either positively or negatively because of contributions made or not made."
He said the proposal could also increase fees for banks and seriously diminish the Federal Reserve's role in developing monetary policy and in policing and helping to quell financial troubles in the U.S. markets.