Banks Would Be Forced to Push Out Derivative Trading Under Plan

http://www.businessweek.com/news/2010-04-14/banks-would-be-forced-to-push-out-derivative-trading-under-plan.html
April 15 (Bloomberg) -- Goldman Sachs Group Inc., JPMorgan Chase & Co. and their biggest rivals would be forced to wall off derivatives trading operations from their commercial banks under a measure to be introduced by Senate Agriculture Committee Chairman Blanche Lincoln, a congressional aide said.

Lincoln, an Arkansas Democrat, will propose a “no-bailout provision” as part of an overhaul of derivatives regulation she plans to unveil today, according to the aide, who declined to be identified because the plan isn’t public. The measure aims to ensure banks don’t endanger depositors’ money with risky trading of over-the-counter derivatives, the aide said.

Along with forcing commercial banks to spin off their swaps dealers to a different corporate entity, Lincoln’s derivatives legislation would bar dealers, exchanges, clearinghouses and other swaps-market participants from being able to take advantage of emergency lending from the Fed, according to the aide.

It would also increase protections for clients by requiring swaps dealers to treat them as a fiduciary -- obligating them to put customers’ interests ahead of the company’s, the aide said.

The measure requires most over-the-counter derivatives to be traded on exchanges or through clearinghouses. Companies that use swaps to hedge the cost of materials or other non-investment purposes would be exempted from the requirements, the aide said.

Like the Volcker rule, which would ban commercial banks from proprietary trading, the wall-off provision would separate derivatives trading from traditional banking activities such as taking deposits and making loans.
Cheaper Funding

 It is also an effort to crack down on the possibility that banks would use cheaper funding provided by deposits insured by the FDIC. to subsidize their trading activities, the aide said.

I am certainly a capitalist. I am not a knee jerk despiser of everything that has "bank" attached to it. I am much in sympathy with Blue Dog goals (and note Lincoln is a BD pusihing anti-corporate bills at least to some level) I'm reasonably financially savvy to graduate degree level albeit not a specialist in the industry, and even *I* can think of no damn reason for derivatives to even be a tradeable instrument at all.

Again I don't know every wrinkle in the financial sector but I have a sound understanding of the basics and I understand what derivatives are. But to me they are nothing but an ephemeral idea. Sure, things like futures trading are not tangible assets either, but at the bottom of them there is still a real commodity, even if in reality futures trades do not actually get recognized by buying or selling that commodity. Derivatives are one step beyond this - a bet based on the value of a bundle of assets that do not and never will actually change hands. When you bet on pork futures going down somebody in the end pays more or less for pork. If you want to gamble in bundled mortgage debts, why not buy or sell bundled mortgages?

There shouldn't be pure speculation with significant leverage.

Useing mortgages for collateral is a recipe for disaster.

They protect you from the consequence of bad decision making so you no longer care and in some cases cheer on the demise of entities. And they allow unqualified counterparties to make a quick buck up front with dangerous future implications if the unexpected occurs.