Obama's Next Big Fight: Big Banks And Derivatives

After vanquishing the insurance companies, President Barack Obama is now moving on big banks and the i i

President Barack Obama speaks in the White House Cabinet Room during a meeting with congressional leaders on Wall Street reform. Alex Brandon/AP Photo hide caption

itoggle caption Alex Brandon/AP Photo
After vanquishing the insurance companies, President Barack Obama is now moving on big banks and the

President Barack Obama speaks in the White House Cabinet Room during a meeting with congressional leaders on Wall Street reform.

Alex Brandon/AP Photo

Having vanquished the insurance companies in order to get his health care overhaul legislation enacted, President Barack Obama has now set his sights on Wall Street's biggest banks whose brisk trade in the volatile and poorly understood financial products known as derivatives nearly collapsed the world's financial system.

In comments to the media before he met with a bipartisan group of lawmakers at the White House Wednesday, Obama said a key piece of the financial-overhaul legislation he hopes to enact is bringing more transparency to the highly opaque world of financial derivatives like the credit default swaps. It was CDS that essentially made American Insurance Group insolvent until federal taxpayers bailed it out.

OBAMA: I am actually confident that we can work out an effective bipartisan package that assures that we never have "too big to fail" again; that consumers are adequately protected when it comes to financial instruments — whether it's mortgages or credit cards or debit cards; that we have a strong mechanism to regulate derivatives, something that we have not had, a derivatives market that is in the shadow economy but is enormously powerful, enormously risky — we want to get that into daylight so that regulators and ordinary Americans know what's going on when it comes to this huge segment of the financial system.

After the meeting, White House Press Secretary Robert Gibbs confirmed that Obama focused the lawmakers on derivatives. According to a summary of the session by Gibbs:

He specifically pushed attendees on derivatives and the recent effort by the financial industry to pressure the Senate to weaken oversight over the same financial products that led to the near collapse of AIG warning that the problems of the future will rest on the steps we take to address derivatives now. He reminded attendees that we proposed a bill almost a year ago and almost two years have passed since the financial industry nearly hit rock bottom, and that Wall Street accountability is long overdue.

Those are essentially fighting words from the president who appears to be threatening a very lucrative Wall Street industry where the largest dealers buy and sell the derivatives between each other. That makes it next to impossible for outsiders to know how much or how many derivatives have traded hands.

Among the changes they seek, the president and other policymakers want more of these financial products to be traded through a clearinghouse that would shed light on these transactions.

Experts expect the financial-services industry, especially the largest banks, to do everything possible to impede or derail this regulatory train.

Robert Litan, a scholar at the Brookings Institution, has written a highly informative and very detailed paper about the derivatives business, an industry he calls the Derivatives Dealers Club (hat tip to BaselineScenario.com) in which he predicts the Wall Street banks will do everything they can to keep a business estimated to being in $30 billion in revenue in a recent year, in the shadows.

... The dealers are thus likely to resist or drag their feet implementing changes
that would reduce systemic risk in the financial system as a whole but that could significantly
reduce the dealers' revenues and related profits from the current arrangement or that make these flows more volatile.

Litan has some ideas how to break down this resistance. He recommends, for instance, hitting the dealers where it hurts — their profits. He would require the big banks to pay fees for transactions not conducted through a central clearinghouse.

In any event, this promises to be a very big fight between the president and Wall Street. Obama clearly shows no signs of backing off. And neither do the big banks.

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