HuffPo's Shahien Nasiripour obtained an e-mail sent to the Senate Banking Committee by Americans for Financial Reform, alerting them to a major loophole, "wide enough to undermine the whole effort to reform a part of the financial market -- those derivatives traded between financial firms, like AIG, outside of any government oversight -- that's largely blamed for worsening the financial crisis."
The financial regulatory reform legislation, which is being shepherded through the Senate by Banking Committee Chairman Christopher Dodd (D-Conn.), attempts to rein in the OTC derivatives market by mandating that most trades go through a clearinghouse, a facility that executes trades for parties that are required to post collateral and mark their positions daily to prevailing market prices. So, rather than two financial firms trading with each other -- with no oversight -- they'd now have to go through this central point. It would shed more light on the market and allow for government regulators to more effectively police it, reformers and Obama administration officials argue.
Standard contracts and those not involving so-called "commercial end users" -- firms like Coca-Cola and General Electric that use derivatives as insurance against currency and interest-rate fluctuations, for example -- will be required to go through these clearinghouses.
The problem, however, is that there's apparently little consequence if firms evade the requirements, according to the email sent to a Banking Committee staffer by Americans for Financial Reform, an umbrella organization of consumer advocacy, public affairs and union groups arguing for reform. Some of these potential loopholes were first identified by Zach Carter of AlterNet.
"[T]here is no consequence for counterparties who enter into uncleared swaps even after a finding by the [Commodity Futures Trading Commission] or [Securities and Exchange Commission] that the swaps must be cleared," the email reads. The bill "does not prohibit the use of uncleared swaps and, even more egregious, expressly states that no swap can be voided for failure to clear."
In other words, if parties to a swaps contract -- a type of derivative that involves regular payments over a specified time period -- do not trade via a clearinghouse when they're supposed to, there's no penalty, the group argues. Also, those swaps can't be deemed invalid because of this evasion.
Furthermore, the email points out, even though federal regulators may require that a swap be cleared, they can't mandate a clearinghouse to accept it....
Lincoln's staff is "willing to get this serious loophole blocked," according to person familiar with the negotiations. The Senate Banking Committee "will have to agree with Senate Agriculture's willingness to see this loophole blocked," the source added.
There's potential for this language to be tightened up prior to the final vote on the bill, or (less likely) in conference. Much, very much, depends on what happens in tomorrow's primary election in Arkansas. Lincoln's derivatives reform already goes too far for the White House, Paul Volker, the FDIC, Chris Dodd and plenty of other Dems. But with the tough reform seen as critical to her re-election bid in this close primary, they've all agreed to postpone gutting it. It's very likely to be watered down in conference, unless Blanche Lincoln is still in her primary in a run-off. If she loses outright tomorrow, there's nothing to save her reforms. If she wins outright tomorrow, she won't care as much about having these strong reforms to appeal to the left, though would still be vulnerable to hypocrisy charges from her Republican opponent.
What that all means is that it's looking unlikely that this loophole is going to be closed.