More oversight of swaps and OTC financial derivatives needed

I frankly don't know how "swaps and derivatives" work, but perhaps I should. Here, Sen. Tom Harkin states more regulatory safeguards could be in order and he observes that speculative money is leaving the futures markets, with substantial consequences to grain prices. From the office of Sen. Tom Harkin of the Senate Agriculture Committee:

Senator Tom Harkin (D-IA), the Chairman of the Senate Committee on Agriculture, Nutrition and Forestry, today questioned the influence of swaps and derivatives on the financial markets and the adequacy of federal regulatory safeguards the week before the Committee is set to explore the issue. Harkin has a history of raising these questions with federal officials. At a February 10, 2000 hearing of the Committee, Harkin, in his position as Ranking Member, questioned the risks of deregulating derivatives and asked then- Chairman of the Federal Reserve System Alan Greenspan and then-Secretary of the Treasury Lawrence Summers about the potential threats to the financial system from potentially high risks in trading of swaps and over-the-counter derivatives.

“Financial swaps or over-the-counter financial derivatives had been exempt from most regulations since 1993. Mainly that meant they did not have to be traded on fully regulated futures exchanges,” said Harkin. “I firmly believe we have to revisit and examine very carefully how these financial swaps and derivatives are regulated – or really not regulated. That is the purpose of my hearing on Tuesday -- to dig into these issues and get some answers. The questions I asked in 2000, and before actually, are still pertinent.

“Clearly, more oversight and regulation of these markets is needed. Swaps and derivatives function in many respects like futures contracts traded on exchanges regulated by the Commodity Futures Trading Commission,” continued Harkin. “For that reason, the Senate Agriculture Committee hearing will explore the scope of CFTC's authority under existing law and whether this authority is adequate in the wake of the current financial crisis.”

Derivatives are financial instruments theoretically intended to limit risk and ward off financial problems. But with some doubts in the market as to how companies would value them, derivatives have created uncertainty and have increased risk. According to a report in The New York Times today, the derivatives market includes contracts and instruments valued at some $531 trillion, up from $106 trillion in 2002 and a relative pittance just two decades ago.

It is now clear that the impact of the financial contagion is spreading to other markets. Agricultural commodity futures prices, especially for grains and oilseeds, have fallen sharply in recent days, and commentary from the U.S. Department of Agriculture detailed in media reports suggests that is not because of substantial new developments in global crop production but is in response to the financial situation and money exiting the futures markets.

The Senate Agriculture Committee will meet in open session at 9:30 A.M. on Tuesday, October 14, 2008 in Room 106 of the Dirksen Senate Office Building to explore the role of derivatives in the current financial crisis and examine regulatory issues pertaining to them. More information about the hearing and Committee action can be found here: http://agriculture.senate.gov/.