US to regulate OTC derivatives

This is long overdue. Of course the big banks are going to lobby against these measures, because any type of regulation/clearing house for OTC derivatives (especially credit derivatives) is going to severely cut into their future profits (bid-ask spreads will drop drop 100s of bps): From the WSJ:

Under a proposed raft of reforms, regulators could be given authority to force many standard over-the-counter derivatives to be traded on regulated exchanges and electronic-trading platforms. That would make it easier to see prices and make markets more transparent.

Firms with large derivative exposures or that trade more-complex derivatives would be subject to new reporting requirements. The proposal also calls for all standardized derivatives to go through clearinghouses that will guarantee trades and help cushion the impact of a collapse of a large financial institution.

The regulatory overhauls are in response to growing concerns of outsize risk and leverage among derivatives that trade directly between pairs of firms. Much trading in this market, estimated to total hundreds of trillions of dollars, now happens privately, and contracts are typically negotiated over the phone.

I suspect that if CDOs/CLOs/CMOs and CDSs move to a clearing house or electronic exchange, it will be considerably more difficult for the banks to apply mark-to-model on these assets. As their balance sheets become more transparent (no more Tier 3 assets), the public will regain there confidence.

The move, the latest step to tighten federal regulation of finance, is designed to address markets such as those for credit-default swaps, which many say exacerbated the financial crisis. Any such moves would require congressional approval.

"Reporting those positions will address the primary concerns of the market, about who is trading what derivatives," said Joel Telpner, a derivatives lawyer at Mayer Brown in New York.

Also Wednesday, Mr. Geithner said the Treasury would soon release a separate plan to simplify which agencies oversee financial markets, a move that could bring sweeping change to the alphabet-soup of regulatory bodies.

"I think the president believes we need to have a much more simplified, consolidated oversight structure," Mr. Geithner told the Independent Community Bankers of America trade group.

The plan to move some trades onto exchanges and electronic trading platforms could reduce profits for investment banks, which currently take fees for facilitating the trades.

The long term solution to credit default swaps may be the holder of the derivative has to have a position in the underlying asset. This will take most of the speculators out of the game, and although that will probably negatively affect liquidity, it will prevent speculators from taking down companies (equity prices are highly correlated with CDS rates).