The head of the Commodity Futures Trading Commission, Gary Gensler, claims his agency is "sorely underfunded" and "we do not have the people to do annual examinations of the clearing houses … " This quote is from an interview with the Financial Times.
For one, the CFTC currently has about 680 employees. Gensler estimates that the agency needs around 1,000 people to be able to police "the $450 trillion swaps and futures market." Right now they only have about 150 people.
A basic rule you that is universally true when it comes to regulators … regulators never have enough money!
In fact the article states "Mr. Gensler's plea for more money is a standard regulator's lament and one that he personally has made many times over the past two years."
In the case of the derivatives market that Mr. Gensler is supposed to police, the immediate issue is about clearing houses. Clearing houses are at the center of the effort to regulate the derivatives market because, in the past, the derivatives market was primarily an over-the-counter market. There was no oversight and there was no information available about transactions. There was concern about who bore the risk and how was it covered.
The clearing houses are supposed to correct for these transactions in the "shadows." Clearing houses guarantee deals between two parties and therefore open up the transaction to the world and to the risk exposure.
But, clearing houses need to be regulated. "Some banks" have warned, "about clearing houses' own ability to withstand market shocks and defaults."
Herein lies the problem … both for now and for the future.
Regulators need to look into every "nook and cranny" of the clearing houses because "risk now lies with the clearing houses." You just don't know what institutions and their clearing houses are going to do. You just don't know what people might try and get away with or what they might try and hide.
Guess what else? You have more and more derivatives trading going elsewhere. For more on this see my post "More Derivatives Trading Now in the Shadows."
Furthermore, there is also the problem of Swaps dealers, also regulated by the CFTC. According to the requirements of the Dodd-Frank financial reform act, swaps dealers now have to register with the CFTC. A total of 82 deals have registered. This is a $400 trillion market.
At the time of this writing, not one swap dealer has been visited by the CFTC. They don't have the people to follow up on the law. But, this goes with the territory.
Have I mentioned this rule yet … regulators never have enough money.
The problems of regulation were just exacerbated when the federal government began to seriously inflate credit in the early 1960s. The end of the 1960s was already sorely testing regulators by the new financial innovations that were forthcoming as commercial banks and others constantly moved ahead of the regulations and the ability to regulate.
Another rule that universally applies to regulators … regulators are always playing catch up.
It's just that over the last fifty years or so, as the credit inflation of the federal government became a perpetual motion machine (except for the Volcker years) and as the advancements in information technology came roaring into financial markets, the task facing regulators became almost impossible.
I was arguing in numerous posts during the construction of the Dodd-Frank bill that the new rules and regulations were already, in most cases, "legacy." I have a New Yorker cartoon where the punch line has to do with bankers asking "which regulations are we going to get around today?"
Laws, rules, and regulations that are aimed at achieving an objective almost always can be evaded in one way or another if the economics is "right." The reason for this is that the "objectives" or "goals" of these efforts are stated and all efforts of the regulators are intended to see that the "objectives" or "goals" are met. Thus, since the bankers "know" what the regulators are attempting to achieve, and if there are incentives to getting around the regulations, then those impacted by the regulations will devise plans to thwart the efforts of the regulators.
The problem is that politicians are very good at telling people what they ought to do … and they get elected and re-elected by getting voters worked up about what rules and regulations need to be imposed on what parties.
My prediction for the future … financial innovation is going to continue to take place and financial regulation is going to continue to fall behind what is going on in the market place.
As usual, the major thing we have to look out for is the "law of unintended consequences."
Credit inflation continues to take place in the United States. Credit inflation produces all sorts of outcomes, one of the primary ones being financial innovation. Since I do not see credit inflation ending any time soon, I have to believe that financial innovation will continue on unabated.
Financial regulation is always behind the curve anyhow, but massive efforts to regulate "the beast" in the context of a major inflation of credit and continued advances in information technology will only "force" financial institutions to innovate even more. Because of this lawmakers and regulators must be cognizant of what "unintended consequences" might result from their efforts.
In many cases, the efforts of lawmakers and regulators may end up causing more pain amongst the people that they are trying to help and actually helping the wealthy which they are attempting to reign in.
The investment advice that flows from this analysis: be aware of what the politicians and regulators are trying to accomplish and then focus in on how the astute "players" and businesses, those that are impacted by the new laws, rules, and regulations, actually respond to these efforts. There you will find investment opportunities.
This also includes the policies of the government. I can't tell you how many (wealthy) people I know that are forming same enterprises to buy up residential properties. This is, of course, goosing up the housing numbers. But, there seems to have been a real shift in the attitudes of American families. Seeing other families burdened with debt and with housing prices in many areas underwater, more and more people are deciding to rent, rather than own their own home.
So, the federal government and the Federal Reserve are just underwriting those that can take advantage of government programs and the low interest rates generated by the Fed. Are you one of those that saw this coming about and took advantage of it? Where else do these opportunities abound?