HEADLINE: How
Will Washington Read the Signs?; Regulation of Derivatives
BYLINE: By Daniel Altman
BODY: After Long-Term Capital
Management imploded in 1998, the Commodity Futures Trading Commission quickly
called for the regulation of over-the-counter derivatives
markets. In the end, Congress decided to take only minimal action. Did that help
limit the damage from Enron's fall, or did it make it worse?
Long-Term Capital, a giant hedge fund, had held trillions of dollars in
derivatives -- complex contracts linked to securities or commodities -- on its
books. Enron, though not a hedge fund, sold a variety of derivatives, from
energy to plastics.
Had Enron been regulated as a
financial institution, investors might have been protected. First, it would have
had to certify its business practices and report its activities, giving
investors a better idea of the risks. Second, its leveraged trades would have
been backed with more collateral, limiting its ability to make huge bets.
Finally, it would have had to set up its derivatives business with separate
financing.
Enron was not required to do any of those
things. "There is a gap there," said Annette L. Nazareth, director of the
S.E.C.'s division of market regulation. "If they had been a broker-dealer, they
would have been regulated; if they had been a futures commission merchant, they
would have been regulated."
Officials of the
derivatives industry counter that Enron's collapse posed little threat to the
financial system. "This institution went bankrupt, and the documentation and
legal principles in place allowed for an extremely orderly clearing and
unwinding of positions," said Robert G. Pickel, executive director of the
International Swaps and Derivatives Association.
But
even as an orderly process, Enron's demise might have been less harmful to
investors had the government regulated derivatives traders more carefully, said
Randall Dodd, director of the Derivatives Study Center, a nonprofit research
institute. With regulation of its trading, Enron might have been forced, both by
rules and the discipline of an informed market, to take smaller risks.
Yet the contrast between the lack of market-shaking
effects now and the disruption caused by Long-Term Capital in 1998, when the
government had to persuade a coalition of big banks to stabilize the financial
system, is likely to dampen enthusiasm for new rules. Daniel
Altman
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