Good afternoon, I’d like to thank the Securities Industry and Financial Markets Association for inviting me to speak today, and thank you Chet for that kind introduction. I’m looking forward to sitting down with Charlie – and as this is the closest I’ll get to the Charlie Rose show, I’ll be brief.
Lessons of 2008
We’ve all drawn many lessons from the financial crisis in 2008. I’d like to highlight a number that I believe are most relevant.
Foremost, when financial institutions fail, real people’s lives are affected. In 2008, the financial system failed and the regulatory system failed as well.
Three years after these twin failures, we’re still feeling the aftershocks. More than eight million jobs were lost, and the unemployment rate remains stubbornly high. Millions of Americans lost their homes. Millions more live in homes that are worth less than their mortgages. And millions of Americans continue struggling each day to make ends meet.
Secondly, high levels of debt – particularly short-term funding at financial institutions – was at the core of the crisis. When market uncertainty grew, firms quickly found that liquidity problems threatened their solvency.
Third, the financial system is very interconnected – both here at home and globally.
Fourth, a perverse outcome of the financial crisis may be that people in the markets believe that a handful of large financial firms will – if in trouble – have the backing of taxpayers. We can never ensure that all financial institutions will be safe from failure. Surely, some will fail in the future. But when these challenges arise, it is critical that taxpayers are not forced to pick up the bill – financial institutions should be free to fail.
Lastly, while the crisis had many causes, it is evident that swaps played a central role.
Swaps added leverage to the financial system with more risk being backed by less capital. They contributed, particularly through credit default swaps, to the bubble in the housing market. They contributed to a system where large financial institutions were thought to be not only too big to fail, but too interconnected to fail. Swaps – developed to help manage and lower risk for end-users – also concentrated and heightened risk in the financial system and to the public.
Congress and the President came together to pass the historic Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act).
The law gave the Commodity Futures Trading Commission (CFTC) oversight of the $300 trillion swaps market. That’s more than $20 of swaps for every dollar of goods and services produced in the U.S. economy. At such size and complexity, it is essential that these markets work for the benefit of the American public; that they are transparent, open and competitive; and that they do not allow risk to spread through the economy.
To date, we have finalized 18 rules to make the swaps marketplace more open and transparent, lower risk to the economy through clearing, enhance market integrity and regulate dealers. We have a full schedule of public meetings into next year to finalize additional important reforms.
The Dodd-Frank Act will bring needed transparency to the swaps markets. The more transparent a marketplace is, the more liquid it is and the more competitive it is. When markets are open and transparent, price competition is facilitated, and costs are lowered for companies and the people who buy their products. In addition, transparent markets are safer and sounder for all participants.
To promote transparency, we have completed rules that, for the first time, give regulators and the public specific information on the derivatives market’s scale and risk. These rules will require large traders to give the CFTC data about their swaps activities and establish swap data repositories, which will gather information on all swaps transactions.
Moving forward, we are working to finish rules relating to the actual data that has to be reported to regulators. These reforms will provide a window into the risks posed by the system so regulators can police the markets for fraud, manipulation and other abuses. We’re also working to finish real-time reporting rules, which will give the public critical information on transactions, similar to what has worked for decades in the securities and futures markets.
Lowering Risk Through Clearing
Another critical reform is lowering risk to the economy by mandating central clearing of standardized swaps. Centralized clearing protects banks and their customers from the risk of the bank failing. Clearinghouses have lowered risk for the public in the futures markets since the late 19th century. Last month, we finalized a critical rule establishing regulatory requirements for derivatives clearing organizations.
I am hoping to soon finish a rule that will enhance customer protections regarding where clearinghouses and futures commission merchants can invest their funds. The market events of the last three years have underscored the importance of maximizing protection of customer funds.
We also are looking to finalize rules on segregation for cleared swaps. Segregation of funds is the core foundation of customer protection.
In addition, after the first of the year, we hope to finish rules on client clearing documentation and straight-through processing.
To enhance market integrity, we finished a rule giving the Commission more authority to effectively prosecute wrongdoers who recklessly manipulate the markets. And we finalized a rule to reward whistleblowers for their help in catching fraud, manipulation and other misconduct in the financial markets.
We also recently completed speculative position limit rules that, for the first time, limit aggregate positions in the futures and economically equivalent swaps market.
To further support market integrity, we are looking to finalize guidance on disruptive trading practices as well as regulations for trading platforms.
It is also crucial that swap dealers be comprehensively regulated to protect their customers and lower risk to taxpayers.
The CFTC is working closely with the Securities and Exchange Commission (SEC) and other regulators to finalize these Dodd-Frank reforms. First, the CFTC and SEC are looking to finish rules further defining the term swap dealer. We are also looking to soon finish external business conduct rules to establish and enforce robust sales practices in the swaps markets. Additionally, we will consider final internal business conduct rules, which will lower the risk that these dealers pose to the economy.
As we finalize these Dodd-Frank rules, we need additional resources consistent with the CFTC’s significantly expanded mission and scope. The swaps market is seven times the size of the futures market that we currently oversee. We also need resources to respond to inquiries from market participants.
In conclusion, the current debt crisis in Europe is but a stark reminder of our interconnectedness. Furthermore, it is precisely during times of heightened market uncertainty that transparent pricing of risk is essential. While European leaders are working to avert a deepening crisis, it is critical that we implement the Dodd-Frank Act to protect the American public and strengthen our economy.
There are those who might like to roll back these reforms and put us back in the regulatory environment that preceded the crisis three years ago. But that regulatory system failed to protect the American public.
Some have raised cost considerations about our rules. We are going through those comments, and they have been very helpful. But far more costly is a public that remains unprotected from the risks of the swaps market.
We must never forget about the eight million lost jobs – the majority of which were lost by people who never used derivatives. We must never forget what the nation went through three years ago – and what the nation continues to recover from now.