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Busch: Washington Takes Over Wall Street

Monday, 19 Oct 2009 | 10:05 AM ET

Late Thursday, the House Financial Services committee approved their bill for financial regulatory reform. The House Agricultural committee is expected to pass their own version on Wednesday. The bill will generate sweeping changes for the financial architecture for OTC derivatives and for the banking industry. The House Financial Services and the House Agricultural committees will have to reconcile the bills before they are ready for a floor vote in November.

"The bill draws a distinction between contracts made between financial institutions and those used by companies to hedge fluctuations in their underlying business. Derivatives contracts between financial institutions that are considered standard would have to be channeled through central clearinghouses that guarantee the trades. Those contracts would also have to trade on exchanges or electronic platforms. And dealers would have to put up some of their own capital to make the trades."

"Nodding to corporations that heavily lobbied Congress, the bill carves out an exception for companies that use swaps, a kind a derivative, to hedge. They wouldn't have to pass through clearinghouses or trade on exchanges. Regulators also wouldn't be required to set margin requirements for companies that are hedging. Dealers on the other side of the trade would have to set aside capital that is higher than that required for standard, cleared swaps."

Sunday in the NYT, columnist Gretchen Morgenson provides the justification for why Congress should act: " Derivatives — contracts that theoretically protect buyers from unforeseen financial calamities but more often are used to fuel raw speculation — were, lest we forget, at the heart of the banking crisis."

Then she makes this statement: "Some swaps buyers also dislike exchange trading because it would require them to put up a cash cushion — or margin — before a transaction. This is to help prevent counterparty failures, but participants in the market prefer not to pay this freight. They’d rather taxpayers foot the bill for a possible collapse later on, as they did with A.I.G."

Regardless of the veracity of these statements, the point to take away is that Congress is acting to make a blanket policy due to this perception. Coupled with the WSJ's article last week detailing that US banks may pay out $140 billion in bonuses to workers, this fuels popular sentiment and voter anger towards the financial industry. It's almost to the point where Congress appears to be willing to make sausage legislation now before mid-term elections in 2010 and then go back to fix it later.

The Senate has yet to take up the bill, but Senator Reed has already put forward his ideas on OTC that are different from the current House Financial Services language. While at this time I don't expect a bill to be ready for the President to sign this year, I believe it is likely there will be one ready before the mid-term 2010 elections next year. Again, change is coming whether it makes sense or not.

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Andrew B. Busch is Global FX Strategist at BMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a frequent CNBC contributor. You can comment on his piece and reach him hereand you can follow him on Twitter at http://twitter.com/abusch.

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