Statement by Senator Michael B. Enzi
On the Derivatives Section
Of S. 3217, the Regulatory Reform Bill
May 12, 2010
I rise today in strong support of Senator Chambliss’ effort to improve the derivatives section of this bill, but I’m disappointed that Senator Chambliss is even required to offer his amendment. Senators Lincoln and Chambliss were well on their way to moving forward with a bipartisan package of reforms for the derivatives market.
This is the market used to hedge against risk, and if we make a mistake in dealing with it, businesses will suffer. Many businesses want to lock in a price, so they hedge their risk. They make a long term commitment to purchase something at a particular price, so they have certainty and avoid the risk that the price will change. For example, many airlines use this market to lock in long term fuel prices they can rely on. That is a derivative. That contract can be bought and sold as the market changes – again to take an acceptable risk. Sometimes I think we call it a derivative so the American people will be confused – and won’t pay attention.
Senators Lincoln and Chambliss were on the verge of putting together a key piece of financial reform in a bipartisan fashion. Unfortunately, buoyed by the passage of the extraordinarily partisan health care reform bill, the White House intervened in negotiations. They urged an end to bipartisan negotiations. They pushed the bill further to the left, and we are now faced with a product that will make it harder for American companies to obtain capital or to assure future purchase prices for essential products. This will drive some American jobs overseas, and perhaps the entire business as well.
It is disappointing that this is becoming commonplace in the Senate. During the health care reform debate, I worked with five other members of the Finance Committee on a comprehensive health care package. We were making progress on a bipartisan bill when the Majority, with guidance from the White House, decided that a “go it alone” approach was better politically.
We are having a debate about the future of our financial industry. We are working to protect our economy from future collapse, and unfortunately, we are having this discussion in a mostly partisan manner because the White House is interested in scoring some political points. It is election year politics at its worst, and I’m disappointed it is becoming the norm.
The White House believes they can win political points on this issue because the word derivative is something of a boogey man. People hear that word and they assume that it is a group of Wall Street bankers plotting how to increase their end of the year bonuses as they seek to ruin the rest of the economy. My constituents are told by fear mongers on the left that derivatives are risky transactions, and they are misled into believing that there is nothing about derivatives that is useful to ordinary businesses.
The facts don’t support those claims. Derivatives are, by their very nature, measures to help limit risk – hedging the bet. The vast majority of Fortune 500 companies and many smaller companies are involved in the derivatives market. Employee pension funds are involved in the derivatives market. The agriculture derivatives market is one of the oldest and most established financial markets in the United States because agriculture can be an inherently risky business unless you lock in a favorable price. Producers are at the mercy of the weather, transportation networks, varying input costs and the global supply of agricultural commodities. These unique market conditions mean that without risk management – markets fluctuate wildly.
I think it could be helpful to those listening to the debate to try to make clear how these transactions actually work. Oftentimes, in business, the greatest potential for profit involves the greatest risk. It only makes sense that I would have greater potential to make money if I invest in a startup company than if I invest in a Treasury bond. It is also more likely that I will lose money with my investment as I invest in that startup company, I may want to limit the chance that I will lose all my money. I want to figure out a way to lessen my risk. Another company may believe that my investment was good, and so I will essentially sell them some of my investment in the startup company – along with my chance for maximum profit – in order to have money to invest in a more stable Treasury bond and less profit. The entity who facilitates that sale is a swaps or derivatives dealer, and they play an important role by helping find willing buyers and sellers to help companies limit exposure – to hedge risk.
The goal of this legislation should be regulating the market in a way that ensures companies, individuals, and other entities can have access to as much money for investment to create jobs as possible at the same time we create a situation where we will never again be forced to bail out the biggest banks and where we never allow another AIG to occur. I’m not convinced that the bill, as written, addresses the concerns, although I feel confident that the bill will lead to less access to money for businesses at a time when our economy is struggling.
In my home state, I’m hearing from the energy industry and from agricultural groups that the bill has the potential to treat companies who are trying to limit risk as major banks. Although the bill does provide an end user exemption, it is unclear if companies can avoid being misclassified as a Swap Dealer or Major Swap Participant and if they are misclassified, they lose that end user exemption. The Chambliss amendment clarifies the end user exemption to ensure that bona-fide hedging transactions, including those used by a wheat grower in Wyoming or a power company in the Midwest, remain regulated in a reasonable fashion.
In a meeting yesterday with Federal Reserve Chairman Ben Bernanke, the Chairman emphasized that what has become known as the “section 106” provisions remain problematic. In the current version of the legislation, the provisions have been moved to Section 716 and require that swap business be conducted in affiliates separate from FDIC-insured banks. Although the idea appears to make sense on its outset, the provision will further reduce access to investment money to create jobs as banks are required to hold additional money in their related businesses to limit credit exposure. Instead of using the capital at the bank to limit credit exposure, they will be forced to have a second pot of money that they will be unable to lend. The provision will result in less investment money entering the market, will lead to further consolidation of the market because fewer institutions will be able to meet the credit risk requirements, and will increase costs to end users.
Putting on my hat as the Ranking Member of the Health, Education, Labor and Pensions Committee, the Chambliss amendment also helps resolve a concern that pension and retirement plans have with the Lincoln-Dodd substitute. Many people do not realize that pension plans dislike big fluctuations in the markets.
Private pension plans invest for the long-term and would prefer to have steady, long-term growth rather than invest in a volatile market which could cause a company’s pension obligation payments to skyrocket when the market falls. Pension plans enter into swap agreements and derivative contracts to hedge price fluctuations and keep risk to a minimum. For example, pension plans use these contracts to make sure that they don’t have too high of an interest rate that may be unsustainable or too low of an interest rate that would give too low of a rate of return that would not provide enough money to pay pensions as they come due. Even the Pension Benefit Guaranty Corporation (PBGC) uses swaps and derivative contracts to dampen the value swings of the pension trust funds.
Recently, 401(k) plans and Individual Retirement Accounts (IRA’s) have begun using “stable value funds” as an alternative to money market funds to offer a very stable and steady increase of earnings. These stable value funds are stable because of the use of swap contracts, again because they make sure that the underlying investments don’t go too high and don’t go too low.
Originally, Senator Dodd’s language in the Banking Committee reported bill may have caused pension and retirement plans to register as “major swap providers”. This of course would not work because the regulation and registration requirements may have run afoul of pension requirements for solvency. Senator Lincoln tried to remedy this but her solution was to place the swap dealers on the spot by requiring special paper work for just touching a swap contract for a pension plan.
I believe that Senator Chambliss’ amendment strikes the right balance. Pension plans are not trying to create a market in swaps nor are they trying to use swaps to game the markets. Pension plans that use swaps assure pension funds will be there when needed and the approach taken by the Chambliss amendment allows that to happen.
The Chambliss amendment is a far superior effort to the bill we have on the floor. At one time, I was confident that we would be seeing a bipartisan, workable Lincoln-Chambliss provision. It is unfortunate that the White House got involved, pushed this bill to the left, and is now pushing us to pass some sort of financial reform legislation – any sort at this stage – at the expense of passing a strong, workable bill. Congress needs to stop with this shoot first, ask questions later approach, or as we call it in Wyoming, the ready, fire, then aim approach that might never hit the target. I hope my colleagues in the Senate can support the Chambliss amendment.