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Goldman Deal-Maker Now Advocates Regulation

For 18 years, Gary G. Gensler worked on Wall Street, striking merger deals at the venerable Goldman Sachs. Then in the late 1990s, he moved to the Treasury Department, joining a Washington establishment that celebrated the power of markets and fought off regulation at almost every turn.

Gary Gensler
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Gary Gensler

Today, he is emerging as one of the nation’s archreformers, pushing to impose some of the most stringent new financial regulations in history. And as the head of the Commodity Futures Trading Commission, the leading contender to oversee the complex derivatives contracts that played a central role in the financial crisis and, in turn, the Great Recession, he is in a position to influence the outcome.

It may seem an unlikely conversion, but it is one that has won the approval of Brooksley E. Born, of all people, a former outspoken head of the commission. She sounded alarms more than a decade ago about the dangers hiding in the poorly understood derivatives market and was silenced by the same Washington power brokers that counted Mr. Gensler as a member.

Mr. Gensler opposed Ms. Born, according to people who worked at the commission in the 1990s, and in 2000 played a significant role in shepherding through Congress deregulation measures that led to explosive growth of the over-the-counter derivatives market.

That was then. These days, Ms. Born is convinced of Mr. Gensler’s reformist zeal, as he takes on Wall Street in what is becoming one of the fiercest battles over regulation in the postcrisis era.

“I think he is doing very well,” she said in an interview. “He certainly seems to be committed to robust oversight of derivatives and limiting excessive speculation and leverage.”

The proposals championed by Mr. Gensler, if adopted by Congress, would substantially alter what is now a largely unregulated market in over-the-counter derivatives, financial instruments used by companies and investors to protect themselves and bet on moves in variables, like interest rates or currencies, and to speculate.

The proposals include forcing the big banks that sell derivatives to conduct their trades in the open on public exchanges and clear them through central clearinghouses, so that any investor can see the prices that dealers charge their customers. Today, those transactions are bilateral and private.

The banks and their customers might have to post collateral or guarantees to prevent the kinds of panics seen during the financial crisis, in which some investors worried that trading partners might have trouble keeping their side of the contract.

In this way, the clearinghouses would work as circuit breakers in the great web of derivatives trading encircling the globe. Shifting the products, and the risk of default, off the books of the banks and onto these middlemen would ensure that no single bank was too interconnected to fail, the rationale goes.

The banks, for their part, sense a threat to the billions of dollars in profits they earn each year from trading in these complex derivatives.

The International Swaps and Derivatives Association, which represents the big Wall Street banks, says that if large dealers are forced to show their prices and trading positions in public, they may be reluctant to participate in the market — and the resulting drying up of liquidity would force up costs.

Conrad P. Voldstad, the association’s chief executive, said that derivatives were not the cause of the crisis. The problem was elsewhere, like subprime mortgages, he says, and those areas should be the focus of any new regulation.

Public statements from the organization’s member banks, however, have been less critical of Mr. Gensler’s proposals. Lucas van Praag, a spokesman for Goldman, said on Wednesday that the company supported letting regulators see derivatives trades and prices in real time, with a delay built in for public disclosure. Goldman also does not oppose a clearinghouse for trades, he said.

“We’re in favor of central clearing for derivatives,” he said. “We also think that all derivatives that can be traded on an exchange should be, but we don’t think it is a good idea to insist that derivatives can only be traded if they’re on an exchange.”

Some big nonfinancial companies that use the derivatives for hedging are fighting the reforms for their own reasons.

Organizations including the United States Chambers of Commerce have formed the Coalition of Derivatives End-Users, representing about 170 companies including Coca-Cola, Caterpillar and General Electric. The group argues that the changes could make derivatives too expensive for them to use — or tie up capital they should be putting to work in their businesses.

“The question is how much is legitimate hedging by corporations” as opposed to speculative trading, said Don M. Chance, a finance professor at Louisiana State University. “You have to be careful you don’t punish companies that want to use swaps in a productive, safe manner.”

Already, it seems, industry lobbying is watering down the changes. As bills have made their way through Congress, some corporate buyers of derivatives, for example, have been exempted from having to trade publicly and through clearinghouses.

Mr. Gensler’s conversion would seem to put him at odds with his mentors, like Robert E. Rubin, the former Treasury secretary, and with his former colleagues on Wall Street.

“Wall Street’s interest is not always the same as the public’s interest,” he says now. “Wall Street thrives and makes money in inefficient markets, and I am creating efficiencies in the market.”

But he denies there has been a change in his stance. At the Treasury, he says, he was obliged to voice the opinions of the institution; that is different from now heading his own agency.

Besides, even at Treasury, he and his colleagues, including Mr. Rubin, had their own concerns about the risks of derivatives.

At the time of the Asian financial crisis in the late 1990s, Mr. Rubin asked him to investigate American banks’ exposure to South Korea through their over-the-counter derivatives positions, and they were amazed, he says, at how little information the banks could provide.

“Knowing what we know now, we should have banged the table more forcefully,” he says.

The American derivatives market was much smaller then, and its dangers were less apparent than they are now. It has grown rapidly over the last decade, to $300 trillion, Mr. Gensler calculates. That is a staggering 20 times the size of the nation’s annual economic output, as Mr. Gensler describes it, aided by high-speed computerized trading and the actions of Mr. Gensler and his cohort in Washington.

Since that time, he says, he has demonstrated his belief in market rules and progressive Democratic politics. After Treasury, he worked as an aide to Senator Paul S. Sarbanes to help draft the Sarbanes-Oxley law, which imposed strict rules and oversight of corporate accounting after the bookkeeping scandals at companies like Enron and WorldCom.

He worked on the presidential campaign of Barack Obama, seeking chief executive endorsements. For that work, he was offered the job at the commission.

At Goldman, Mr. Gensler made partner by age 30 and earned his fortune. Mr. Rubin, also a Goldman alumnus, brought Mr. Gensler to Treasury. From him, Mr. Gensler says, he learned “that process matters. He always ran a very inclusive process.”

“What’s so marvelous about Bob,” he continued, was that “he fostered in people the ability to think. He wanted to hear differing ideas.”

Mr. Gensler, 52, denies that his current position puts him at odds with what Mr. Rubin stood for. They still talk now, about every six months.

During his first year at the Treasury, he was excluded from matters involving derivatives after it became clear that his former employer, Goldman, was lobbying hard on the issue.

It was then that Ms. Born began to ask whether the fast-growing and poorly understood market needed greater oversight, inviting an aggressive reaction from Mr. Rubin; Lawrence H. Summers, Mr. Rubin’s deputy at the Treasury; and Arthur Levitt, the chairman of the Securities and Exchange Commission.

The Commodity Futures Modernization Act of 2000, backed by the likes of Mr. Rubin, sidelined the trading commission even more than before. If Congress agrees to reverse many of the measures contained in that law, Mr. Gensler says he intends to rebuild the commission by increasing its staff to about 1,000, from 600 today, and by increasing the computing power at its disposal to try to keep up with Wall Street’s traders.

The new rules would be policed by the S.E.C. and the trading commission, giving Mr. Gensler’s group a new and bigger role after years in the background. The agency would assume oversight for about 90 percent of the over-the-counter market, he estimates; today it has few oversight powers.

“I disagree with anyone who says derivatives did not play a part in the crisis,” he said in defense of more oversight. He added: “Like San Francisco after the earthquake, we had a calamity, and now we need building codes.”