Thursday, February 10, 2011


It doesn’t take a rocket scientist to figure this out:

Without a new tax on the securities industry, there won’t be reform of same.

The drumbeat has started. The question is who is listening? And who is prepared to act on the completely unsurprising message that is being sent …

The quick summary is this:

The Securities and Exchange Commission says it does not have the resources to implement and enforce all the features of the Dodd-Frank Wall Street Reform Act asks of it. Already, it looks like it’s trying to turn the implementation of a uniform fiduciary standard for brokers and advisers over to the Financial Industry Regulatory Authority, the brokers’ self-regulatory organization.

The Commodity Futures Trading Commission says it does not have the resources to implement its responsibiities under the Dodd-Frank act. And this is the regulator that is supposed to oversee the biggest and boldest reform that is supposed to come out of the reform: The establishment of and oversight of exchanges and execution facilities along with central clearing for “standardized” credit default swaps.

It was, of course, the introduction of those quasi-insurance policies, where big banks and American International Group swapped the risk of default on credit-based derivative securities, that made financial markets comfortable they could handle mortgage-backed securities and other complex new instruments that Warren Buffett so long ago declared “financial weapons of mass destruction” that were “potentially lethal.”

Hmmm. The sage was right. Back in 2002.

But this is 2011, with budgeting going on for 2012.

Here’s how CFTC chairman Gary Gensler, he of Goldman Sachs heritage, described his agency’s resources in testimony before the House Committee on Agriculture, Subcommittee on General Farm Commodities and Risk Management:

Before I close, I will briefly address the resource needs of the CFTC. The futures marketplace that the CFTC oversees is approximately $40 trillion in notional amount. The swaps market that the Dodd-Frank Act tasks the CFTC with regulating has a far larger notional amount as well as more complexity. Based upon figures compiled by the Office of the Comptroller of the Currency, the largest 25 bank holding companies currently have $277 trillion notional amount of swaps.

The CFTC’s current funding is far less than what is required to properly fulfill our significantly expanded role. The CFTC requires additional resources to enhance its surveillance program, prevent market disruptions similar to those experienced on May 6 and implement the Dodd-Frank Act.

The President requested $261 million for the CFTC in his fiscal year 2011 budget. This included $216 million and 745 full-time employees for pre–Dodd-Frank authorities and $45 million to provide half of the staff estimated at that time needed to implement Dodd-Frank. The House of Representatives matched the President’s request in the continuing resolution it passed last week. We are currently operating under a continuing resolution that provides funding at an annualized level of $169 million. To fully implement the Dodd-Frank reforms, the Commission will require approximately 400 additional staff over the level needed to fulfill our pre-Dodd-Frank mission.

And his commission members this month are sending all kinds of signals that Dodd-Frank can’t be implemented unless some new source of funding is forthcoming.

Commission member Michael V. Dunn at a public meeting on proposed Dodd-Frank rules last Wednesday:

“We lack the staff and resources necessary to both implement Dodd-Frank and continue to fulfill our pre-Dodd-Frank duties under the Commodity Exchange Act . Without additional funding, the strain will only become worse in July, when much of Dodd-Frank goes into effect.’’

Commissioner Scott D. O'Malia at a Tabb Forum on Derivatives Reform a week ago, on the possible fallout:

"I have serious concerns about the cost of clearing … I believe everyone recognizes that the Dodd-Frank Act mandates the clearing of swaps, and that as a result, we are concentrating market risk in clearinghouses to mitigate risk in other parts of the financial system." He said regulators such as the CFTC will be challenged to implement the new rules in ways that do not make it “too costly to clear.”

And then there was this rather conspiratorial outburst from commissioner Bart Chilton at gathering of institutional investors in New York, also last Wednesday:

"Opponents of reform could not stop the Dodd-Frank Act from becoming law …"Therefore, now they have another idea—a double secret strategy. They seek to deny resources to regulators—starving us on the vine if you will—and thereby denying us the ability to enforce the new law and oversee these markets.''

This is where the potential of some sort of new tax to fund Dodd-Frank reforms comes in.

If the opponents succeed in putting a stranglehold on Congressional funding of regulators, the regulators instead are likely to be forced to impose fees on users of capital markets, to implement the reforms, Chilton said.

"If we are faced,’’ he said, “with the draconian option of no funding to implement the reform bill, putting us directly back where we were in 2007 and 2008 when the economic mess began to show its ugly head, then perhaps some type of user fee is the least onerous remedy.’’

Here’s his formula:

Approximately a billion-and-a-half contracts are traded on regulated commodity exchanges in the U. S. every six months. If market participants are charged even a third-of-a-cent transaction fee on those trades, "this could provide the funds to do our jobs,'' he said.

User fees should not just be placed on futures contracts, he said. They should also be placed on swaps transactions, he said, which is the "new area of regulation" where the commission's workload is increasing.

Over at the SEC, there’s already precedent for transaction-based fees.

In fact, that regulator, which has only a small portion of swaps to oversee, sent out this rate advisory on December 15:

Effective Jan. 21, 2011, the Section 31 fee rate applicable to securities transactions on exchanges and over-the-counter markets will increase from its current rate of $16.90 per million dollars in transactions to a new rate of $19.20 per million dollars in transactions. The Section 31 assessment on security futures transactions will remain unchanged at $0.0042 per round turn transaction.

Of course, the Dodd-Frank bill passed Congress when both houses were run by Democrats, backing a Democratic president. Now, the House is dominated by Republicans. And this is what the chairman of the House Financial Services Committee, Spencer Bachus of Alabama, said (also last week) about how much money the SEC already was receiving. And how well it has been spent.

“The SEC is currently funded at more than $1.1 billion, the Dodd Frank authorizes that to be increased to $1.5 billion for fiscal year 2012, almost identical to Chairman Schapiro’s request. Less than ten years ago the SEC's budget was approximately $400 million. While I have previously stated that Chairman Schapiro is making the SEC a more responsive agency, during the same period of increased funding, the SEC missed the Madoff and Stanford Ponzi schemes; operated a failed investment bank supervisory program that was unsuccessful in preventing the Bear Stearns and Lehman failures; and whose payroll still includes employees who appeared to have been more interested in surfing the Internet for porn leading up to the crisis than policing the financial markets for fraud. As I said last year, past experience indicates that a few investigative reporters have been more effective than the many employees at the SEC in addressing and exposing financial wrongdoing. “

The Bachus response logically would be to fund a core group of investigative reporters to take on oversight of financial markets. ProPublica, are you available?

So Dodd-Frank is coming down to this: Rules, without the funds to enforce them. Or, a new tax – call it a ‘user fee’ -- on the industry to actually make reform happen.

Tom Steinert-Threlkeld

February 2, 2011

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