ECONOMY NOVEMBER 7, 2013
Bart Chilton, the colorful, mullet-sporting member of the Commodity Futures Trading Commission (CFTC), resigned this week, after casting a final vote to set position limits, which would regulate the number of commodity trades individual speculators can hold. Chilton’s farewell speech focused on his 5-year odyssey in support of a rule on position limits, which was finished, then overturned by the courts in 2012, then rewritten to answer the judicial challenges. He described it as his final piece of unfinished business. He also included a familiar farewell sentiment, which, in his case, was probably especially true: “It’s with incredible excitement and enthusiasm that I look forward to being able to move on to other endeavors.”
You can hardly blame Chilton for being excited to leave the CFTC. The chief regulator for over $300 trillion worth of derivatives trades has seen its operations squeezed by drastic underfunding, right at the time the Dodd-Frank financial reform law dropped a whole new set of responsibilities in its lap. While the rule-writing process is important—and Wall Street lobbyists have fought hard for exemptions and loopholes on derivatives rules—the lack of resources has made rules almost irrelevant, since the CFTC simply cannot enforce them. The agency is being hollowed out from the inside, yet another way that the financial industry can achieve its goal of gaining the freedom to ignore the law in pursuit of profit.
Dodd-Frank rewrote the rules for over-the-counter derivatives (or “swaps”), putting most of them under regulation for the first time. These opaque bets on bets played a major role in the financial crisis, magnifying the collapse of the housing market and spreading the damage throughout the financial system. The lack of transparency revealed a hole in the regulatory framework; companies like AIG could issue massive amounts of risky swaps without regulators’ awareness. So Congress decided that, instead of negotiating trades over the phone in private, the over-the-counter derivatives market would have to be transparent, traded on open exchanges, with the data available to market participants and their overseers. The 17 exchanges, known as swap execution facilities, post the price and volume of all trades, bringing this shadow market into the open for the CFTC to monitor. We no longer would have to guess about the exposure of big banks and financial firms to these risky bets.
Except the CFTC does have to guess, basically. The swap execution facilities launched on October 1, the same day 95 percent of agency staff were forced onto furlough by the government shutdown, and the agency has been playing catch-up ever since. But the problems go back much further than that. Marcus Stanley of Americans for Financial Reform (AFR), a leading reform coalition in Washington, puts it simply: “(CFTC) is the only financial regulatory agency that’s not at least partially self-funded.” While other agencies impose fees on the businesses they regulate and collect fines from regulatory enforcement to fund operations, the CFTC has never had authority to do so. This means that Congress alone holds the purse strings for the agency, and can use its discretion to effectively gut reforms by limiting resources. Particularly since the Republican takeover of the House in 2011, Congress has done just that.
The annual operating budget for the CFTC stands at $205 million. For context, Marcus Stanley notes, the information technology budget for just one multinational bank is $2.4 billion, over 10 times as much. In an arms race between traders and their primary regulator, it’s simply no contest. The CFTC budget has increased around 85 percent over the past five years, but that’s not nearly enough to manage the new responsibilities under Dodd-Frank, particularly to do the work of aggregating derivatives data, identifying patterns and determining where risk is pooling. The nominal value of the markets the CFTC must regulate has ballooned to well over $340 trillion, from $40 trillion prior to Dodd-Frank, a nearly ten-fold increase. Dealing with this significant new burden requires both innovation and a bigger labor force. But with a staff of 672, the agency only has 40 more employees than it did 20 years ago, according to Chairman Gary Gensler, who is also departing the CFTC at the end of the year
It’s just not possible for even a fully staffed and functioning CFTC to monitor the swaps market under the current constraints. And sequestration, the automatic cuts to every part of the federal budget, has made this worse. The cuts trimmed $10 million from the budget, which will force CFTC to engage in staff furloughs of up to 14 work days in 2014. “They’re working their people 12-hour days to get things done, and then they have to furlough them,” Marcus Stanley of AFR noted. “No matter how many hours they work, they can’t get the job done on monitoring until they have more staff.”
Despite a legal staff of just over 100, the CFTC collected $1.7 billion in fines over the past year. However, that money is not allowed to flow back into the agency budget. And the budget crunch has had a significant impact on enforcement. The outgoing CFTC enforcement chief, David Meister, said in an interview with the Wall Street Journal that he had to decline to file charges against two JPMorgan Chase traders in the “London Whale” case because of a lack of funds. Other cases have either been delayed or shelved. This past year, the agency’s 82 enforcement actions were down one-fifth from 2012.
So if you’re a Wall Street derivatives trader, and your primary regulator has practically no staff to manage a flood of data, and practically no enforcement capabilities to deal with misconduct, the implications are clear. Derivatives, supposed to be under the watchful eye of the government for the first time, are effectively a free-fire zone. There’s virtually no check on the kinds of risks that accelerated the financial crisis, and traders are free to push the envelope in search of quick profits. Defunding the CFTC makes not only derivatives less safe, but endanger the whole economy.
The Obama Administration has sought a 50 percent increase in funding, to $315 million, each of the last three years. Marcus Stanley, of Americans for Financial Reform, describes this as the bare minimum request needed to keep the lights on, hire maybe 300 more staffers, and fulfill the basic regulatory functions. And as a percentage of the overall budget, another $105 million each year would be almost invisible. But Republicans rebuffed the request, with Senate Minority Leader Mitch McConnell arguing, “The less we fund those agencies, the better America will be.”
“The House (Republicans) know they have their hands around the CFTC’s throat,” Stanley said. “They’ve bent over backwards to hold down funding. And they’ve said they’ll only raise it if the Administration agrees to gut the regulations.” Similarly, legislation to allow some form of self-funding for the CFTC—so their enforcement actions or some new user fee on trading can be poured back into the agency—has been dead on arrival in Congress. Even some Democrats, like Dick Durbin—whose home state of Illinois has a significant commodities business—has resisted the self-funding idea.
It’s no surprise, then, that Chilton and Gensler—the strongest voices for reform at the CFTC—are walking away from the agency, perhaps in frustration, just as the regulatory apparatus ramps up. The administration’s rumored replacements, Timothy Massad and Sharon Bowen, are both ex-Wall Street lawyers without a deep background in commodities or derivatives markets, and if nominated, they will have to learn on the job with a skeleton staff, and a ready suite of industry lobbyists with far more resources willing to educate them. And that’s if they get confirmed quickly; by January the Commission will be down to two out of five commissioners, unable to move forward on new rulemaking and lacking leadership amid a budget crisis.
Perhaps it’s no accident that one of the most critical holes plugged by Dodd-Frank, oversight of the derivatives market, comes down to a rickety agency that simply cannot handle the new burden. This gives Wall Street another chance to maintain the status quo—if they can’t change the legislative language, fight the law in the courts, or water down the rules in implementation, they can always let Congress do their bidding by defunding the regulators. “The CFTC is a weak choke point in the system,” Marcus Stanley said. “You can throttle derivatives reform by choking down CFTC funding.”
David Dayen is a contributing writer at Salon.