Senator Warren and Representative Cummings Push for Information on Swaps
Commentary by Steven Lofchie
In a letter sent to four financial regulatory agencies, U.S. Senator Elizabeth Warren and Representative Elijah Cummings criticized the Congressional repeal of Section 716 of Dodd-Frank. According to the letter, the American people and their elected representatives lack adequate information about the risks of the repeal. Without that information, the two lawmakers wrote, "the country risks moving blindly" toward a "financial meltdown."
Senator Warren (D-MA) and Representative Cummings (D-MD) sent the letter to the Board of Governors of the Federal Reserve, the Office of the Comptroller of the Currency, the FDIC and the CFTC. It contained a list of questions for the regulators to answer, including a number that requested the "total value" of the swaps contracts that banks will not be required to push out in light of the partial repeal.
Commentary
It is always good when Congress asks questions about the operations and effect of its legislation. It would be better, however, if Congress asked questions in advance of adopting legislation that could have a massive effect on the U.S. economy. Before Senator Warren and Representative Cummings ever voted to adopt Section 716, one hopes that they had some idea of the potential costs imposed by the legislation and its possible effect on the economy.
That said, it will be difficult for the regulators to answer the questions posed by these legislators. The questions themselves reflect a certain misunderstanding of the nature of swaps. For example, questions about the "value" of swaps cannot be answered meaningfully. Even an extremely large swap may have no "value," particularly if the asset to which the position relates has not changed in price since the parties entered the swap. Further, even assuming that the swaps held an in-the-money position with the banks and so had a positive "value," in what way would that information be useful or significant? Would the argument for moving the positions out of the banks carry any more weight if the swaps had a high value and not a low value?
The most conspicuous omission in this Congressional inquiry is not an absence of information about the "value" of swaps but a meaningful attempt to understand the purpose and uses of swaps. The letter leaves one with the impression that swaps are a rather extraordinary type of financial instrument with a different kind of risk associated with them than other types of financial instruments. This is simply not the case. The most significant fact to know about swaps activities that are conducted by banks is that most swaps are essentially credit transactions, not unlike loans. They are effected through well-established and standardized forms of documentation with which all financial regulators are quite familiar. As a result, if regulators want regulated banks (as opposed to "shadow banks") to be in the credit business, then the regulators should push for swaps market-making to be conducted in regulated banks.
By partially repealing Section 716, Congress made the financial markets much safer by allowing regulated banks to continue to engage in credit activities that are both intrinsically within their expertise and fundamental to the management of a modern economy.