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U.S. Treasury Secretary Timothy Geithner on Friday proposed clamping down on dealers in freewheeling markets for little-understood derivatives that helped create a crisis in U.S. and world financial markets.
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CNBC.com Treasury Secretary Timothy Geithner |
In testimony at a joint hearing by two congressional panels that will play a role in writing legislation on derivatives, Geithner set out proposals that would make big dealers like JPMorgan Chase and Goldman Sachs subject to much stronger supervision than was the case in the past.
"We propose to require all OTC (over-the-counter) derivatives dealers ... to be subject to substantial supervision and regulation, including conservative capital requirements, conservative margin requirements and strong business conduct standards," Geithner said, essentially acknowledging there were few limits in the past.
The Obama administration has been trying to bring about a sweeping overhaul of the U.S. financial regulatory system in the wake of a two-year old financial crisis that has hobbled economies world-wide.
Its proposals on derivatives are just one small piece of this larger proposed revamping, which will face months of political wrangling before anything is put into law.
In the United States, four big banks control more than 90 percent of derivatives markets: JPMorgan Chase [JPM
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], Bank of America [BAC
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], Citigroup [C
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] and Goldman Sachs [GS
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]. Derivatives are financial instruments that derive their value from an underlying asset like a Treasury bond, a commodity like oil or copper or a mortgage-backed security.
Geithner told the House Financial Services and Agriculture committees that the existing system allowed some financial institutions to sell large amounts of derivatives, which are intended to offset or manage risks, even when they do not have the capital to back those commitments.
He cited the example of insurer American International Group [AIG
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], which has required huge infusions of taxpayer funds to prevent its collapse, as among "the most conspicuous and most damaging" of these types of firms.
Geithner said that, among reforms, it wants the Securities and Exchange Commission and the Commodity Futures Trading Commission to have authority to impose recordkeeping and reporting requirements on all over-the-counter derivatives.
"Our plan will help prevent market manipulation, fraud and other abuses by providing full information to regulators about activity in the OTC derivative markets," he said.
The $450 trillion privately-traded global derivatives market includes credit default swaps, the financial instrument that nearly toppled AIG.
The SEC and the CFTC would also have clear authority for civil enforcement and regulation of fraud, market manipulation and other abuses under Geithner's proposals.
The administration is also trying to encourage greater use of standardized contracts to help push the instruments onto central clearing houses, exchanges and electronic trading platforms.
That has stoked concern among financial institutions who say certain contracts are customized to their clients and not meant to be cleared or traded on an exchange.
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