CFTC's Gensler turns back on Wall Street to push derivatives overhaul


By Ian Katz and Robert Schmidt
Bloomberg News
Friday, February 12, 2010

WASHINGTON -- Gary Gensler, chairman of the Commodity Futures Trading Commission, is shattering any illusions that his 18 years at Goldman Sachs Group Inc. would make him sympathetic to Wall Street's effort to weaken derivatives legislation.

Over a private lunch at the Waldorf Astoria hotel on Jan. 6, Gensler, 52, told bank executives that while he once shared their goals -- to boost revenue and increase their bonuses -- his responsibility now was to American taxpayers. And if he gets his way, Gensler said, their firms will be less profitable, according to three people familiar with the discussion.

Attending the lunch were David B. Heller, co-head of the securities division at Goldman Sachs; Seth Waugh, chief executive officer of Deutsche Bank Americas; Timothy O'Hara, head of global credit at Credit Suisse Holdings USA Inc., and Robert P. Kelly, CEO of Bank of New York Mellon Corp. When one banker asked Gensler what he sees as the biggest obstacles to reform, he gestured toward his hosts and replied, "You."

Of all the regulators in the Obama administration, Gensler may be the most troubling to Wall Street, Bloomberg BusinessWeek reported in its Feb. 22 issue. In public speeches and congressional appearances, he seeks derivatives legislation that goes beyond what President Barack Obama proposed last summer.

His campaign to drag the $605 trillion over-the-counter derivatives market out of the shadows is designed to lower spreads between buyers and sellers and make it easier for new competitors to enter the market, ultimately depriving banks of billions of dollars in profit. On Capitol Hill, he goes toe-to- toe with lobbyists to try to stop them from winning even minor language changes that would create loopholes the financial industry might exploit.

Gensler "is going to raise real concerns" for financial firms, said Samuel Hayes, a professor emeritus of investment banking at Harvard Business School in Boston. "Derivatives are absolutely central to what is Wall Street in the 21st century. Nobody wants the regulations to affect them."

Michael Greenberger, a former CFTC director of trading and markets who opposed Gensler's deregulatory efforts as a Treasury official in the Clinton administration, said that "if there were no Gary Gensler involved in this, I think the legislation as crafted would not be as strong as it was." Greenberger is now a professor at University of Maryland School of Law in Baltimore.

Gensler said in an interview that he was trying to make clear at the bankers' lunch that their interests are to maximize the profits of their shareholders and "to maximize their own individual compensation. We shouldn't confuse that it's set up for the taxpayers."

Congress is considering tightening oversight of derivatives as part of a broader revamping of financial industry rules. Gensler wants the Senate to toughen a bill passed by the House in December that would impose stricter trading rules on dealers, including JPMorgan Chase & Co. and Goldman Sachs, while allowing exceptions Gensler opposes for end-users, typically non-financial companies that use derivatives to hedge risk.

Gensler's goal is to move OTC derivatives to transparent trading systems that regulators can monitor. Once traded, he wants most deals to be processed through clearinghouses, which are privately owned third parties that guarantee transactions and keep track of collateral and margin. Gensler agrees with lawmakers that the legislation should not be as rigid for customized derivatives that are written for a particular client and do not actively trade, which he has estimated is 20 percent of the market.

The five biggest U.S. players in derivatives -- Goldman Sachs, Bank of America Corp., JPMorgan Chase, Citigroup Inc., and Morgan Stanley -- had $52.83 billion in revenue from trading derivatives and cash securities in the first nine months of 2009, according to Federal Reserve reports. Goldman Sachs was the largest with revenue of $19.8 billion, followed by Bank of America's $10.64 billion and JPMorgan's $9.34 billion. Citigroup showed revenue of $6.84 billion and Morgan Stanley, $6.21 billion.

Gensler, a Baltimore native, worked at Goldman Sachs from 1979 to 1997, mostly in mergers and acquisitions and later as head of debt and currency trading in Japan. In 1999 and 2000, under then-Treasury Secretary Lawrence Summers, Gensler fought for passage of the Commodity Futures Modernization Act, which exempted over-the-counter derivatives from regulation.

That law, which President Clinton signed in 2000, has been blamed for allowing the rapid growth of leveraged markets in derivatives such as credit-default swaps, contributing to the $1.7 trillion in losses banks have suffered since 2007. Former Federal Reserve Chairman Alan Greenspan and former Securities and Exchange Commission Chairman Arthur Levitt Jr., both of whom supported the 2000 law, have expressed regret that derivatives were not more tightly controlled.

So when Obama nominated Gensler to run the CFTC in December 2008, consumer groups had reason to think Gensler would not be an ally.

It hasn't turned out that way. "He's been the strongest advocate of reform" in the administration, said Barbara Roper, director of investor protection for Washington-based Consumer Federation of America. "Given his background, there was a certain amount of skepticism," Roper said.

Brooksley Born, the former CFTC chairman whose efforts to regulate OTC derivatives were opposed a decade ago by the Treasury, the Fed and the SEC, said she's "pleased with the positions he's taken publicly" at the CFTC.

"I think Gary Gensler is committed to robust regulation of the derivatives markets and the prevention of excessive speculation," Born said in an interview.

Gensler also has pressed for rules on energy futures. On Jan. 14, as the result of his prodding and lawmaker complaints that speculators had driven oil prices to a record high in 2008, the CFTC proposed limits on the number of positions a trader can hold. Commodity-linked businesses like airlines and oil companies are allowed to exceed the limit.

Derivatives are financial products whose values are based on other assets and can be used to hedge against changes in stocks, bonds, commodities, currencies, interest rates and weather. They've been used by companies including Continental Airlines Inc. to hedge fluctuations in fuel prices and Coca-Cola Co. to control currency risk.

After his nomination was delayed for five months by lawmakers suspicious of his history, Gensler cultivated relationships with Congress, which will decide how strict any legislation will be and the CFTC's budget and staffing levels. Obama on Feb. 1 requested a funding increase of 55 percent, to $261 million, if legislation to ramp up oversight passes.

He is on Capitol Hill often. Sometimes he briefs legislators or their staffs on how markets work and the basics of derivatives; at other times, he negotiates over complex details, he said. His lawmaker ties deepened in September when his deputy chief of staff, Robert Holifield, was named staff director of the Senate Agriculture Committee, which oversees the CFTC.

Gensler's years at Treasury and Goldman Sachs -- at age 30 he became one of the firm's youngest partners -- make him a formidable foe for Wall Street, CFTC Commissioner Bart Chilton said. In agency discussions on how firms trade and account for their transactions, "we've had times when someone says, 'The banks tell us they can't do that,'" Chilton said. "And Gary says, 'That's crazy. I used to do it all the time.'"

Much of the debate in Washington revolves around end-users -- manufacturers that use derivatives to offset the risk of energy-price swings, for example, or financial companies that use the instruments to hedge interest-rate risk. Gensler is lobbying senators to strike an exemption in the House-passed measure that would relieve end-users from costly requirements to clear their derivatives deals, post collateral, and pay into margin accounts.

In a Feb. 3 letter to all U.S. senators, about 180 companies and groups representing end-users said some of the proposed reforms "would place an extraordinary burden" on them. "The loss of these important risk-management tools would be detrimental to businesses, the economy and job creation," they wrote. Ford Motor Co., Procter & Gamble Co., Boeing Co., and Walt Disney Co. were among the companies.

If he can't get rid of the exemption, Gensler said, he hopes to narrow it as much as possible so that "hedge funds or other financial actors" can't slip through the loophole.

Exempting end-users could permit up to 60 percent of standard transactions to escape the rules, Gensler said, citing statistics from the Basel-based Bank for International Settlements. Industry groups have argued that end-user transactions make up less than 15 percent of the standard market.

The CFTC chairman often fights an uphill battle. When industry lobbyists wanted to broaden the end-user exemption to include firms that use derivatives to hedge against "balance-sheet risk," Gensler told lawmakers that the term was too broad. His effort failed in the House, though he hopes to knock the provision out of the not-yet-written Senate measure.

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