House panel divided on new financial rules

Debate on new oversight for complex financial instruments moved to the House on Tuesday as lawmakers struggle to determine how tight the government reins on a massive global market should be.

A key lawmaker said a balance must be struck in crafting a new regulatory system for derivatives, the mostly unsupervised instruments blamed for hastening the global financial crisis.

Forcing all derivatives contracts to be traded on government-regulated commodity exchanges "may cast too wide a net" because some of them are customized, or tailored to the trading partners, said Rep. Paul Kanjorski, D-Pa. But allowing too many derivatives to avoid regulation could touch off another financial disaster.

"We ... must find a delicate balance," said Kanjorski.

At a hearing of the House Financial Services subcommittee he heads, Kanjorski indicated support for the approach behind the Obama administration's plan for regulating credit default swaps and other financial derivatives to reduce risks of another meltdown.

Credit default swaps, a form of insurance against loan defaults, are traded in a secretive international market valued at about $60 trillion. They played a prominent role in the financial crisis that gripped world economies last fall.

The administration plan involves a network of clearinghouses to provide transparency for trades in credit default swaps and other derivatives. Many derivatives, however, would continue to be traded privately in a multitrillion-dollar market worldwide rather than on commodity exchanges regulated by the government.

At the same time, the big investment banks that trade the "over-the-counter" derivatives would be subject to requirements for holding capital reserves against risk and for business conduct and other rules.

The plan is similar to legislation proposed by a small group of major Wall Street banks.

Fault lines over a new financial architecture ran deep at Tuesday's hearing. Some Democrats, striking a populist tone, called for stricter regulation of derivatives to avoid a new financial catastrophe. Republicans warned that too-tight oversight could stifle the flow of cash through the derivatives market and drive business overseas.

With 94 percent of the 500 biggest international companies using derivatives to manage risk, Congress "needs to tread carefully as it looks at regulatory options for these markets," said Rep. Scott Garrett of New Jersey, the subcommittee's senior Republican. "Over-regulation or improper regulation that might sound good politically could have major unintended negative consequences."

Critics also say the administration's plan may not be robust enough and would give the same banks that bear responsibility for the financial crisis exclusive control over a big slice of the derivatives market, since they would be running the clearinghouses.

If new U.S. regulations drove some derivatives trading overseas, "let that casino be offshore," said Rep. Brad Sherman, D-Calif. "Let some other government bail out" the next American International Group Inc., he added.

The collapse of credit default swaps brought the downfall of Wall Street banking house Lehman Brothers Holdings Inc. and nearly unraveled the big insurance conglomerate known as AIG last fall, prompting the government to support the company with about $180 billion in support.

The value of over-the-counter derivatives hinges on an underlying investment or commodity - such as currency rates, oil futures or interest rates. The derivative reduces the risk of loss from the underlying asset. About $600 trillion of those contracts are held worldwide.

Kanjorski asked for industry players' input as the panel prepares to draft legislation that could have a profound effect on financial markets. Elements of that measure must include new requirements for transparency in the derivatives trading market and for capital cushions against risk to be held by market participants.

"I'd like you to help us," he told executives of JPMorgan Chase & Co.; 3M Co., the maker of Post-it notes and Scotch tape that is a heavy derivatives user; commodity exchanges; and the International Swaps and Derivatives Association, a trade group representing hundreds of banks and other companies worldwide.

In the Senate, Agriculture Committee Chairman Tom Harkin, D-Iowa, wants all financial derivatives to be traded on regulated commodity exchanges and has proposed legislation to do that.

But such a move "would effectively stop any such business from being conducted" and damage the U.S. economy, Robert Pickel, executive director of the ISDA, said at Tuesday's hearing.