One of the key aspects of the financial reform bill was to put restrictions on derivative trading by banks. But it has emerged that there are still serious differences among two senators who were entrusted with the job of shaping the rules.
Senators Jack Reed and Judd Gregg were given the task of drafting the rules that limit the amount of risk that banks take with the money of the depositors, but they don’t seem to be getting anywhere close to consensus on the issue. In fact, when Senator Christopher Dodd, the Chairman of the Senate Banking Committee, made the revised draft of the reform bill public last Monday, he had to use the same language that was inserted in the very first version of the bill.
The existing language for the proposed rules had come for criticism from both Democrats and Republicans, with the former saying that the rules were too weak and the latter saying that they went too far.
Reed accepted that they were finding it very difficult to reach agreement on the rules but he hoped that with some more effort and changes in the language they should be able to get bipartisan support behind the bill. Gregg also said that although some progress had been made, a lot more needed to be done to reach a stage where both parties were comfortable with the bill.
The idea is to enforce some restrictions on derivatives trading so that banks do not take extreme risks, the kind that led to an almost complete collapse of the financial sector in 2008. It has also been suggested that a larger percentage of these rules should be made public so that the market is aware of the risk that a bank is taking. It is expected that with increased transparency about their transactions, banks would not take undue risks with their money.
Derivatives trading has been blamed for the serious systemic risks that exist in the financial industry. Leading business figures like Warren Buffet, the hugely successful investor, have repeatedly warned that derivatives were like ticking time bombs for the financial system and that they posed catastrophic risks.
This kind of trading is usually conducted to cover risks like foreign exchange fluctuation or oil price shocks for companies. But in the hands of Wall Street banks and hedge funds, they have become a tool for placing huge bets worth billions of dollars.