WASHINGTON - The Treasury Department yesterday joined the growing chorus of federal agencies telling Congress that legislation is not needed to regulate the derivatives markets.
"While the Treasury believes that these markets deserve considerable attention, thought, and study, there is no imminent threat that requires a quick, aggressive legislative response," Darcy Bradbury, the Treasury's deputy assistant secretary for federal finance, told a House subcommittee.
"Hurried legislative responses run the risk of being counterproductive," Bradbury said at a hearing held by the House Agriculture Committee's environment, credit, and rural development subcommittee.
The subcommittee held the hearing to consider the General Accounting Office's recent report on derivatives and an earlier derivatives study by the Commodity Futures Trading Commission.
The General Accounting Office reports calls on Congress to immediately enact legislation to ensure that all derivatives dealers are subject to comprehensive and consistent federal regulations - particularly the derivatives affiliates of securities firms and insurance companies that are virtually unregulated by federal agencies.
The subcommittee would be in a position to consider such legislation later this year when it must reauthorize the Commodity Futures Trading Commission. The legislative authority for the commission expires in October.
But Bradbury, the Treasury's point person on the interagency Working Group on Financial Markets, said that it would be "premature" for Congress to try to address derivatives now and that Treasury supports a simple five-year reauthorization bill for the futures commission.
"We do not believe that sufficient information has been developed at this time to conclude that the unregulated derivatives affiliates of registered broker-dealers and insurance companies should be brought under a comprehensive scheme of federal regulation," Bradbury told the subcommittee.
"As a general principle, there should be a demonstration that there has been or will be a failure of market discipline before the need for such broad federal regulation is advanced," she said.
Bradbury acknowledged that some corporations suffered major losses from derivatives after using them for speculative purposes. The losses should make other derivatives market participants cautious, she said, but should not be the basis for new legislation or regulation.
"It has not been U.S. government policy for sophisticated U.S. corporations to be protected by regulation from making bad business decisions with respect to their finances," she said.
Both Bradbury and Brandon Becker, director of the Securities and Exchange Commission's division of market regulation, said that their agencies have the tools they need to regulate and monitor derivatives.
Bradbury said the Working Group on Financial Markets is examining several derivatives issues. They include: what information is available to the government; how mutual funds and pension funds are using the products; what capital, accounting, and disclosure standards are needed for market participants; and whether "bilateral close-out netting" would be available to a market participant that became insolvent.
Another key issue under study by the group is whether derivatives would exacerbate several market movements, she said.
James Bothwell, a General Accounting Office officials, told the subcommittee that some market experts believe that derivatives had a significant and unexpected impact on recent interest rate movements.
Bothwell said that the Federal Reserve raised short-term rates with the expectation that long-term rates would fall and dampen inflation fears. But when home owners stopped prepaying their mortgages in response to the raising short-term rates, he said, some investors realized they would be holding collateralized mortgage obligations longer than planned. They "dumped" their long-term bonds. As a result, he said, the prices of long-term bonds fell and interest rates rose.
Federal Reserve officials could not be reached for comment.
Several subcommittee members, particularly the Republicans, appeared skeptical or outright opposed to a legislative remedy for derivatives concerns.
The International Swaps and Derivatives Association, whose chairman, Gay Evans, testified at the hearing, and the American Bankers Association, which submitted a written statement to the subcommittee, said that derivatives market participants are taking steps to address derivatives concerns and that the GAO's call for legislation is unsubstantiated.
But the GAO's Bothwell told the subcommittee that the swaps association "severely mischaracterizes what we're saying in our report" and "misrepresents the implications of our recommendations."
Bothwell said that ISDA claims that the GAO's recommendations, if adopted, would increase costs and reduce the availability of derivatives.
But GAO is merely recommending that "certain basic regulatory safeguards" be extended to securities firm affiliates and insurance companies, he said. The safeguards would include the ability to examine, and set capital standards for, the derivatives activities of such entities.
"This regulatory structure already exists for the major banks," Bothwell said.
GAO's recommendations would mostly affect only about 15 firms, or the major derivatives players, he said. These include seven banks, five securities firm affiliates, and three insurance company affiliates, he said.
The United States is the only major industrialized country that does not federally regulate all of its derivatives not federally regulate all of its derivatives dealers, GAO officials said at the hearing.