Did a Secret Wall Street Memo Make Geithner Go Soft on Derivatives?

| Tue Jun. 2, 2009 12:20 AM EDT

Given that credit default swaps caused the largest financial crisis since the Great Depression, you'd think that the folks responsible for them, people who are now surviving on the taxpayer dime, might be laughed out of Washington if they were to suggest that they be the ones to decide how to regulate them. Sadly, it's the opposite.

On Monday, the Times' Gretchen Morgenson published a little-noticed but excellent piece about the CDS Dealers Consortium, a group created in November by the nine biggest participants in the derivatives market to lobby against stricter regulation of derivatives. The move came a month after five of them had received bailout money. The group's head lobbyist, Edward J. Rosen, who was paid $450,000 by the banks for four months, wrote a secret policy memo that he shared with the Treasury Department and leaders on Capitol Hill. A few months later Tim Geithner released a suspiciously similar regulatory plan. 

It gets much worse: in February Rosen testified before Congress on derivaratives without disclosing his ties to the CDS Dealers Consortium. From 2007 to 2008, five banks in the consortium spent a combined $47.7 million on campaign donatations and lobbying.

Geithner's bank-friendly plan to regulate derivatives would force them to be traded on a privately-managed clearinghouse, rather than on an open exchange, similar to the stock market, where many experts believe that they'd be less subject to manipulation. Morgenson reports:

Critics in both the financial world and Congress say relying on clearinghouses would be problematic. They also say Mr. Geithner's plan contains a major loophole, because little disclosure would be required for more complicated derivatives, like the type of customized, credit-default swaps that helped bring down A.I.G. A.I.G. sold insurance related to mortgage securities, essentially making a big bet that those mortgages would not default. . .

But increased transparency of derivatives trades would cut into banks' profits — hence the banks' opposition. Customers who trade derivatives would pay less if they knew what the prevailing market prices were.

The Times piece is long, but reading it goes a long way towards understanding what is often a huge gulf between the Obama Administration's rhetoric and its tepid approach to bank regulation.