Six Fixes for Wall Street: Repeal the Commodity Futures Modernization Act

While the president and congress are prescribing placebos for Wall Street ailments, Barry Ritholtz, CEO of Fusion IQ and author of Bailout Nation, is proposing six hard medicines for financial regulation reform.  I offer my thoughts on each. 

Repeal the Commodity Futures Modernization Act. This rule “allowed derivatives to be exempt from all the rules that affect every other traded financial instrument,” and was a root cause of AIG’s problems, Ritholtz says.

If the absence of Glass-Steagall allowed the cancer to spread, the Commodity Futures Modernization Act (CFMA) is partially responsible for creating it in the first place.  Passed in 2000 as another deregulation-era reform, it first drew controversy in 2001 after the collapse of Enron.  Among other things, it allows most derivatives to be traded over the counter.

Over the counter markets are largely why the modern world of derivatives is like the wild west.  They represent an array of self policed, unregulated agreements totaling trillions of dollars of value.

Credit default swaps for example, the products at the root of the AIG debacle, ballooned into a  $45 trillion notional value market without an exchange or clearinghouse to mitigate counterparty risk or increase transparency.  Credit default swaps act as a kind of insurance against credit default and allow participants to make bets on default risk similarly to making a bet on a stock.

Better regulation here brings transparency to these largely hidden markets and forces institutions to act more prudently when taking risk.