Shortly after nine on a Monday morning in late April, Commodity Futures Trading Commission (CFTC) Chairman Gary Gensler filed into a meeting room with nine senior aides. The aesthetic was what you might call “bureaucratic drab”—fluorescent lights, beige carpeting, American flag—and the mostly middle-aged men did not seem out of place. Their suits ranged from gray to charcoal and the complexions were varying degrees of pasty. Many wore looks of mild disbelief, as though at a loss to explain their presence so soon after going to bed.
The CFTC is the federal regulator whose primary responsibility is to oversee derivatives, essentially bets on movements in financial data like bond prices and interest rates. In the past decade, much of the derivatives market has grown up outside the government’s reach, which helps explain how AIG massively overdosed on them. At the time of the April meeting, Congress was on the verge of enacting a package of derivatives regulations, and Gensler had gathered his team to figure out where the late-inning negotiations had left them.
Gensler, who is short and lean with eyes like a Pokémon character, promptly slouched in his chair at the head of a conference table and eased off his loafers. “Let’s do the side-by-side,” he said. “What I’d like to do is, as fast as humanly possible, tell me where we think the merged bill is.”
Everyone in the room now considered a 19-page document listing 38 provisions related to derivatives. For each provision, the document summarized where the Senate bill stood, indicating where Gensler could breathe easy and where he should keep pressing. “Foreign exchange?” Gensler asked. “I’m putting Senate Ag and a check mark—we’re fine.” “Swap dealers?” he continued, “We’re fine.” “Set-aside segregation requirements. ... This is, like, huge. We like this, right?” As the team worked through the list, it became clear that the bill had, if anything, become stronger. Even the occasional question mark seemed to work out for the best. “Do we have the Eddie Murphy provision?” Gensler wondered, alluding to a statute he’d named after the star of the 1980s Wall Street comedy, Trading Places. “Insider trading—that’s the Eddie Murphy—that stayed in,” he confirmed.
Basic political science tells us that, when Congress targets a complex industry with billions of dollars at stake, the legislation should weaken as it moves toward passage. The industry will plead its case with vehemence, while voters will be oblivious to the importance of subtle changes. “Words on the page are not that critical to the public,” one derivatives industry lawyer told me in March, conveying a general truism. But something unforeseen is happening as Congress wraps up its overhaul of Wall Street: Key elements of the bill are getting tougher—in some cases markedly so. And no subplot illustrates this dynamic more vividly than the one starring Gary Gensler.
Gensler’s unlikely derivatives crusade began only hours after Obama named him to head the CFTC. That’s when incoming White House chief of staff Rahm Emanuel informed him that Minnesota’s Collin Peterson, chairman of the House committee that oversees the agency, was preparing a statement opposing the nomination. The 51-year-old Gensler was a former partner at Goldman Sachs, and Peterson was wary of his Wall Street ties.
Gensler promptly called Peterson at home and persuaded him to holster his statement, but he was hardly in the clear. Washington Senator Maria Cantwell worried that Gensler would be soft on derivatives. Vermont’s Bernie Sanders was skeptical of Gensler’s tour under Treasury Secretary Robert Rubin. The two senators would eventually block his nomination, demanding assurances that he and his Obama colleagues planned to rein in the financial markets.
The suspicions weren’t necessarily unfair. In 2000, the Clintonites had joined forces with Republicans to exempt so-called over-the-counter derivatives from regulation, and Gensler had played a supporting role in the effort. But his Treasury experience had also made him appreciate the chaos that derivatives could wreak. In 1998, Rubin had dispatched him to inspect the books at Long-Term Capital Management (LTCM), a hedge fund on the verge of collapse. Gensler was startled to learn that LTCM's derivatives portfolio had tied it to so many firms that its failure could threaten the financial system.
And so, when Treasury Secretary-designate Timothy Geithner, Gensler’s fellow under secretary during the Clinton years, pitched him on the CFTC job, the chance to reform the derivatives market held real appeal. As Gensler would testify last February, he believed the Clintonites hadn’t done enough to protect the public. “There’s not a day that goes by that I don’t think what we might have done differently,” Gensler told me at the time.
Cantwell finally relented on Gensler’s appointment in May 2009, after Geithner sent a letter to Congress committing to a hawkish regulatory scheme. Among other things, he favored requiring most derivatives to be “cleared”—meaning the two sides of each deal would place their bets through a middleman, to which they’d have to post collateral. (That wasn’t the case with AIG, which is why its housing-market losses could have brought down the banks it had bet with.)
By early summer, though, the Wall Street skeptics had reason to worry again. The big banks that trade derivatives had mobilized hundreds of sympathetic customers—the industrial companies that use derivatives to lock in prices of inputs like oil and steel—rather than do the brunt of the lobbying themselves. The “end users” flocked to Capitol Hill to complain that the new regulations would raise their costs. Moderate Democrats on Barney Frank’s House Financial Services Committee took up their cause, agitating for an exemption so wide it would even include hedge funds.
The administration now had a choice: It could accept a wider exemption than it supported in principle, so as to improve the bill’s prospects in the House. Or it could hold firm and risk failure. Treasury opted for the weaker bill when it sent legislation to the Hill on August 11. “The House committee was where it was,” says one Treasury official. “We were not keen to draft something up that wouldn’t have worked.” Gensler, for his part, still favored the harder-line approach and told Geithner as much behind closed doors.
This much was hardly unexpected, as Geithner had solicited the views of regulators like Gensler. It’s what came next that raised eyebrows. One week after Treasury unveiled its legislation, Gensler outlined his reservations in a public letter to Congress. It was a step Gensler had indicated he might take, but the follow-through caught Treasury off guard. “It’s possible he felt he’d given us a sense of it ... but it didn’t penetrate the consciousness,” says the Treasury official. “We were definitely surprised when we read it, that I can say for sure.”
Whatever the case, Gensler’s zeal served as a counterweight to the natural rightward drift on the Hill. Every week, he seemed to appear before another industry group insisting that no financial company should escape the new regulations. When Frank put out a discussion draft that weakened the bill further, Gensler promptly testified that the proposal “could have the unintended consequence of exempting a broad range of entities,” even big financial institutions. “He’s turned a rinky-dink commission into the most powerful agency in the federal government when it comes to derivatives,” one industry lobbyist told me. A key upshot was to galvanize a coalition of labor unions and activists who, in meetings with Frank and his staff, stressed that derivatives could cost Democratic seats if they didn’t clamp down.
By the time the House passed its financial-reform bill last December, the derivatives provision was far from ideal—the new regulations appeared to exempt most hedge funds and insurance companies. But it was somewhat stronger than many would have predicted. Still, no one had any illusions about the endgame. It’s an article of faith on Capitol Hill these days that legislation from the House, where the leadership can exert near-ironclad control over the rank and file, will be more progressive than what passes the Senate, where moderates can cut their own deals and Republicans can thwart action with a mere 41 votes.
To anyone who was looking, the first sign that the usual logic might not apply came in late fall. As it prepared to weigh in with the Senate, Treasury noticed that the climate on derivatives was shifting—that the opposition from Wall Street and its industry allies was being matched by a reformist passion on the center-left. And so, whereas tactical considerations had once dictated trimming the bill’s ambition, Treasury now worked to beef it up.
At first, the administration’s new tack had little discernible effect. For months, Chris Dodd, chairman of the Senate Banking Committee, led a bipartisan negotiation aimed at building a hefty majority on the Senate floor, the result of which, many feared, would be a porous bill. But, in late March, Democrats high off their health care victory became frustrated with GOP obstructionism and abruptly scheduled a vote. After a mere 21 minutes, all 13 Democrats on the Banking Committee supported the measure, which reflected the administration’s tougher approach to derivatives.
Most lobbyists continued to believe the derivatives piece of Dodd’s bill would disappear once Senate Agriculture Committee Chairman Blanche Lincoln negotiated a compromise with her Republican counterpart, Saxby Chambliss. (The Agriculture Committee shares jurisdiction over derivatives.) What the industry hadn’t realized was that, as the White House pivoted to financial reform, derivatives were rocketing up its priority list. One reason was strategic: The White House began to recognize that derivatives might be more hospitable terrain than, say, the too-big-to-fail problem, the solution to which Republicans dishonestly dubbed a “permanent bailout.” “Rahm’s view is: ‘I like the derivatives issue,’” says one administration official. “ ‘We’re on better ground on that than talking about bailouts. If they talk bailouts, we talk derivatives.’ ”
Unbeknownst to Wall Street, the new White House focus had transformed the Dodd bill from a legislative ideal—worth striving for but unlikely to pass intact—to a minimally acceptable standard. Two weeks later, when Lincoln’s staff began circulating the outlines of a bipartisan compromise, Treasury’s response was unequivocal: The administration couldn’t support the deal because it was a retreat from Dodd’s position.
That left Lincoln with a problem. Her plan had been to attract enough Republicans to offset defections by a handful of liberals on her committee. Now it turned out that a bill forceful enough to win Obama’s imprimatur would almost certainly cost her those Republican votes, meaning she’d need to keep the Democrats united. Lincoln accomplished this by outflanking the administration on the left. The result was an apparent lurch from the weakest derivatives bill in Congress to the strongest.
One derivatives-industry lawyer I spoke with recently recognized the handiwork of a certain federal regulator: “I think Gensler drafted it, his staff put it together from various pieces,” he told me. “It does embrace [certain restrictions] which the administration asked not to be included.” When I asked Gensler about this role, he downplayed it but didn’t disavow it. “Sure, there’s lots of language that we’ve helped with,” he told me. “We’ve given technical advice. It’s inaccurate to say it’s ‘our language.’” Regardless of who deserves credit, the bill quickly gained steam: In addition to every Democrat on her committee, Lincoln also picked up the vote of one Republican.
What explains the unexpected success? The financial-services industry had counted on public passion subsiding with time. As the derivatives lawyer told me a few weeks ago, “The current strategy you’re hearing is basically to keep Republicans together till cooler heads prevail.” But cooler heads aren’t prevailing. As the bailed-out banks have surged back to profitability while unemployment hovers near 10 percent, the public has, if anything, grown crankier. By holding the line on a tougher reform package, the White House has been able to ride the anger rather than get trampled by it. In a moment of rising public frustration, the populist argument gains force the longer the debate continues.
There’s just one catch: In drafting her bill, Lincoln included an idea that Gensler denies authoring—a provision that would force big banks like Goldman Sachs to spin off their derivatives businesses if they want access to credit from the Fed. The administration is cool to the proposal, which it fears might make the system less stable, as are many Senate Democrats. But, given the public mood, no senator wants to be linked to its death. At one point, New York Senator Kirsten Gillibrand filed an amendment simply requiring federal regulators to assess the idea before voting to implement it. But Gillibrand never offered it up because she and other Democrats didn’t want to slow the momentum behind an otherwise solid bill. It’s a funny thing about populist fervors: Once unleashed, no one can say where they’ll end.
Noam Scheiber is a senior editor of The New Republic.