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Gensler Evolving in Derivatives Sees No Deed Go Unpunished

Gary Gensler, chairman of the Commodity Futures Trading Comm
Chairman of the Commodity Futures Trading Commission, Gary Gensler. Photographer: ZUMA Press/Newscom

Gary Gensler, chairman of the Commodity Futures Trading Commission, took his seat before a Senate appropriations subcommittee on May 4 to make his case for a $106 million budget increase.

Without the money, Gensler said, his agency wouldn’t be able to perform its new job of policing roughly $300 trillion in U.S. over-the-counter derivatives, a market that includes the credit-default swaps that helped push the U.S. economy into the worst recession in 70 years, Bloomberg Markets magazine reports in its August issue.

“In 2008, both the financial system and the financial regulatory system failed the test for the American public,” Gensler, 53, told the senators. “An investment in the CFTC is warranted, because, as we saw in 2008, without oversight of the swaps market, billions of taxpayer dollars may be at risk.”

Even before Gensler had a chance to make his rounds at the Republican-controlled House, he got its response. Representative Jack Kingston, a Georgia Republican, proposed a spending bill on May 23 that called for a 15 percent CFTC budget cut to $172 million.

Although the Dodd-Frank Wall Street Reform and Consumer Protection Act required the commission to write and enforce more than 50 new rules regulating derivatives trading and commodities futures, Gensler, who’d gotten an increase for the current year, needed to tighten his belt starting on Oct. 1, as at other agencies, Kingston said.

‘Thinking Has Evolved’

The news was the latest blow to the former Wall Streeter, who has been knocked around repeatedly since he began advocating in 2009 that the huge derivatives market had to be controlled -- and that his CFTC was the agency to do it.

As a Goldman Sachs Group Inc. partner and then Treasury undersecretary, Gensler had lined up with the hands-off-derivatives crowd behind the $601 trillion global market.

He says the near-collapse of the world’s financial system changed his mind about regulation.

“My thinking has evolved,” Gensler says in his ninth-floor Washington office, which is decorated with artwork by his three daughters. “I was part of the consensus view on derivatives, and it’s fair to say that the consensus missed it. We should have done more to protect the American people.”

Gensler is an unlikely agitator for reform. While he was at the Treasury, the administration of President Bill Clinton refused to regulate OTC derivatives, the financial instruments that derive their value from an underlying asset. Gensler helped push an anti-regulation bill through Congress in 2000.

‘Deregulatory Orientation’

When President Barack Obama tapped him to head the CFTC in December 2008, Vermont’s independent senator, Bernie Sanders, said Gensler was beholden to Wall Street and blocked the nomination.

Senator Tom Harkin, an Iowa Democrat, foresaw more of the same anti-regulation sentiment.

“I remain concerned about the deregulatory orientation in this nominee’s past,” he said.

Gensler faced confirmation hearings in February 2009 when the financial universe was on shaky ground. Companies worldwide had taken almost $1.45 trillion in writedowns and eliminated about 250,000 jobs.

The Dow Jones Industrial Average had plunged 33 percent in 2008 as unregulated trading in credit-default swaps, a form of OTC derivative that banks and hedge funds used to insure against loan defaults, brought down American International Group Inc. and helped sink Lehman Brothers Holdings Inc.

AIG Bailout

AIG had run a lucrative business selling the swaps, which paid out if debt investments, including the subprime mortgage securities fashioned by Wall Street, defaulted. When AIG couldn’t meet its obligations, the government bailed out the insurer to the tune of $182.5 billion in 2008 and 2009.

During the hearings, Gensler pledged that he’d bring the unregulated swaps market under control. And he agreed with Sanders that the CFTC, which already regulated commodities futures from orange juice to crude oil, would tighten rules to curb speculative trading.

The Senate confirmed him by a vote of 88 to 6 in May 2009. After that, he lobbied lawmakers to give the CFTC more power and was the only agency chief to sit through the final 20 hours of House-Senate committee negotiations on Dodd-Frank.

A runner who’d completed a 50-mile ultramarathon in 2007, Gensler shows off a photo of the participants gathered around a conference table at 5 a.m. on June 25, 2010.

“I wanted to be there,” says Gensler, recalling the Dodd-Frank victory.

‘Ganging Up’

Gensler has had little time to savor the win. Former banking colleagues, lawmakers and corporate America are doing all they can to slow his regulation drive.

“Everyone’s ganging up on him -- Wall Street, the GOP, Fortune 500 companies,” says Michael Greenberger, a University of Maryland law professor and a former CFTC director of trading and markets. “All this fighting is making getting the regulation right more difficult.”

The CFTC commissioners voted 5 to 0 on June 14 to postpone the rules regulating derivatives trading until Dec. 31, 2011. Some parts of Dodd-Frank that relate to swaps rules were set to take effect on July 16. The agency hasn’t finished many of the details, such as which banks and hedge funds will be designated as swaps dealers.

“It’s a lot on our agenda,” Gensler said at the CFTC meeting in Washington.

Wall Street Profits

Wall Street has emerged as Gensler’s biggest nemesis. JPMorgan Chase & Co., Bank of America Corp., Citigroup Inc., Goldman and Morgan Stanley controlled 96 percent of the $321 trillion derivatives contracts held by U.S. banks in the first quarter, the Office of the Comptroller of the Currency says. The $321 trillion notional amount represents the estimated value of the assets that underlie the derivatives.

Goldman and the others make more than $30 billion in annual profit in financial derivatives trading, according to financial consultant Oliver Wyman, a unit of Marsh & McLennan Cos., the world’s second-biggest insurance broker.

Dodd-Frank would weaken that grip. The law, which gives the CFTC regulatory powers over 80 percent of the U.S. derivatives market, pushes as much swaps trading as possible onto futures exchanges and to new trading platforms called swap execution facilities.

Dodd-Frank also specifies that most swaps trades be settled through clearinghouses, which require firms to pay membership fees, provide money to cover trades and have minimum amounts of capital. Before Dodd-Frank, banks, insurance companies and hedge funds weren’t required to set aside money to cover potential losses. They made their own agreements about how much collateral, if any, to put up. The CFTC is writing the rules that govern the specifics for its portion of the market.

New Battleground

“Wall Street has moved the battleground from the halls of Congress to the corridors of CFTC,” says Tyson Slocum, director of the energy program at consumer advocate Public Citizen, who backs tighter regulation of swaps markets.

Goldman executives came calling at the CFTC 52 times from last August to mid-June, according to the agency’s website. Morgan Stanley managers paid 33 visits and JPMorgan Chase officials dropped by 26 times in the same period. It isn’t just big banks that are pestering Gensler: Asset manager BlackRock Inc. came for 25 meetings; hedge fund Citadel LLC had 15.

‘Perfect Lobbying Storm’

“This is a perfect lobbying storm,” says Marcus Stanley, policy director of Americans for Financial Reform, which is seeking greater regulation. “The people who understand the most about the fine print are the ones making money.”

Capitol Hill is buzzing with anti-reform sentiment. The House Financial Services Committee approved a bill by a vote of 30 to 24 in May that called on the CFTC to delay implementing any swaps rules until Sept. 30, 2012.

Representative Spencer Bachus of Alabama, the committee’s chairman, says regulators need more time and information. Bachus, a Republican, raised about $1.1 million last year from political committees of banks, securities and investment firms, real-estate and insurance companies and their employees, according to the Center for Responsive Politics, which tracks campaign finance.

Democratic Senators Charles Schumer and Kirsten Gillibrand of New York, joined by all 16 of the state’s House members, wrote to Gensler on May 17, seeking exemptions for Wall Street from parts of the derivatives rules. Last year, Schumer raised $5.1 million from the political committees of the banks and other sources that the Center for Responsive Politics noted for Bachus. Gillibrand raised $2.4 million.

900 Meetings

Wall Street and its political allies aren’t the only would-be spoilers. Gensler and his staff have held a total of more than 900 meetings, including hundreds with lobbyists ranging from Delta Air Lines Inc. to the National Petroleum Refiners Association.

Under Dodd-Frank, swaps users must set aside money to cover potential losses. Airlines and utilities that use derivatives to hedge against price fluctuations are seeking exemptions, arguing that such margin requirements would force them to tie up millions of dollars. Under CFTC proposals, for example, a corporation that trades more than $100 million in swaps may not be eligible for any exemptions.

Even brewers are challenging Gensler. Craig Reiners, commodities-risk manager at MillerCoors LLC, the No. 2 U.S. beer company, says that if the cost of hedging rises significantly, swaps may no longer be economical for corporations. A 3 percent margin requirement would drain more than $500 million in liquidity from the beermaker, he says.

Representative Jeb Hensarling, a Texas Republican, warned that such rules could raise the price of a cold draft.

‘Price of a Six-Pack’

“I think you just got the attention of the American people,” Hensarling said at a House Financial Services Committee hearing on Feb. 15.

Gensler, who doesn’t drink alcohol, was quick to respond. “We’re aware and focused on the cost of a six-pack,” he said.

Gensler’s own commissioners are throwing up roadblocks. The Republicans on the five-member board, Scott O’Malia and Jill Sommers, are undercutting him on key regulations. Democrat Michael Dunn has questioned the CFTC proposal on position limits. In December, O’Malia offered an amendment on a proposal that would have required swaps dealers to provide prices to all market users before any trade, according to CFTC director of public affairs Scott Schneider. Gensler retracted the proposal and the board approved a revised proposal a week later, which allowed a buyer to see prices from a select number of traders.

SEC’s Shadow

Operating in the glare of global finance is a change for the CFTC, which has labored in the shadow of the Securities and Exchange Commission. President Gerald Ford created the agency in 1974 to oversee futures trading in all commodities, replacing the Commodity Exchange Authority.

The most-recent serious attempt to regulate OTC derivatives began in 1998. Gensler, then assistant Treasury secretary, worked with Secretary Robert Rubin and Rubin’s deputy, Lawrence Summers. The three joined former Federal Reserve Chairman Alan Greenspan to torpedo a proposal by CFTC Chairman Brooksley Born to regulate swaps.

Gensler, who says he recused himself from many discussions because of his Goldman background, says the conventional wisdom was that markets were capable of regulating themselves. Two years later, he was one of the Treasury officials responsible for shepherding the Commodity Futures Modernization Act of 2000 through Congress.

Position Limits

Sponsored by Republican senators Phil Gramm of Texas, Richard Lugar of Indiana and introduced by Representative Thomas Ewing of Illinois, the bill exempted OTC derivatives from regulation and oversight.

Now, Gensler’s rules would curb the clout of big derivatives players. The CFTC has proposed a 20 percent limit on the stake that financial companies can own in clearinghouses and exchanges. And it wants clearinghouses to allow firms with as little as $50 million in capital to become members.

Dodd-Frank also gives Gensler power to set trading curbs, called position limits, that would rein in speculation in his existing bailiwick: commodities futures and related swaps. He says speculation in oil futures sent crude prices above $140 a barrel in 2008 and gasoline to around $4 a gallon. Crude oil was trading around $94 a barrel on June 21.

“Position limits help to protect the markets both in times of clear skies and when there is a storm on the horizon,” he says.

Gensler’s critics say he’s meddling too much. John Damgard, president of the Futures Industry Association, which represents futures and options markets, says the CFTC shouldn’t use position limits to curb speculation.


“He’s overreaching his authority,” Damgard says. The futures markets are used mainly by corporations to hedge their fuel and commodities costs and by institutional investors and hedge funds. “The people using our markets are not some little old lady. They are sophisticated institutional investors who wouldn’t use these instruments if they thought the market was not functioning,” he says.

Public Citizen’s Slocum isn’t buying that argument. He says the groups lined up against Dodd-Frank are the same ones profiting from trading swaps.

“Banks make money when there is less transparency,” he says.

Gensler, now at the center of high finance, grew up with his twin brother, Robert, in a working-class Baltimore neighborhood. Their father owned a vending-machine business. The brothers studied math in a program at Johns Hopkins University for gifted teenagers.

‘Brilliant Even Then’

Both went to the University of Pennsylvania’s Wharton School. Gary graduated summa cum laude from Wharton in 1978 with a bachelor’s of science in economics and then earned his MBA there in 1979. Robert ended up at Salomon Brothers and is now a vice president and portfolio manager at T. Rowe Price Group Inc. in Baltimore.

“Robert and Gary were brilliant even then,” says Daniel Alpert, a classmate and a founding managing partner at New York investment bank Westwood Capital LLC. “You couldn’t tell them apart, but Gary was maybe more public-minded and active in student affairs.”

Gary joined Goldman in 1979 and made partner in 1988, the same year as did future CEO Lloyd Blankfein. Gensler, at 30, was one of the youngest partners; Blankfein was 34.

Gensler advised the National Football League in 1990 television negotiations, winning a record contract that earned each team $32 million a year, up from $17 million in the previous pact. He spent three years in Tokyo heading currency trading and fixed income before returning to New York to serve as co-head of finance.

New Challenge

Gensler says he was looking for a new challenge after 18 years on Wall Street. He joined the Treasury in 1997 as assistant secretary for financial markets.

“He brought market savvy,” says Gensler’s boss, then-Undersecretary John Hawke.

Gensler provided market expertise as the Treasury eliminated three-year notes in 1998 and reduced sales of five-year notes to once a quarter from monthly auctions.

As for promoting Wall Street interests: “I never saw anything that indicated any proclivity to Goldman Sachs views or positions,” says Hawke, who became comptroller of the currency before joining the law firm Arnold & Porter in 2004.

Identical twin Robert, younger by three minutes, was the mischievous one. Gensler says Robert would get a kick out of breezing by Treasury security guards and Rubin congratulated Robert by mistake when Gary was sworn in.

Gensler left the Treasury in 2001 and joined the staff of Senator Paul Sarbanes of Maryland as a senior adviser. He helped write the 2002 Sarbanes-Oxley Act on corporate finance. The same year, he published “The Great Mutual Fund Trap: An Investment Recovery Plan” with now-JPMorgan counsel Gregory Baer.

Daughters Weigh In

The book lambasted the $24 trillion industry for maintaining that managers could beat the market while charging high fees. Gensler advocated that investors switch to index funds, even though his twin was a star stock picker.

Gensler, who’d moved his family to his native Baltimore in 2004, became a single father in 2006 when his wife, Francesca Danieli, died from breast cancer. He stayed in Baltimore until last year so that his daughters -- Anna, now 21, Lee, 19, and Isabel, 14 -- could remain in familiar surroundings.

His daughters nudged him back into the limelight. “The girls were saying, ‘Dad, you’ve got to get out of the house,’” Gensler says.


He joined Hillary Clinton’s presidential campaign as senior economic adviser. After Clinton conceded, he says he was recruited by Obama’s team.

Since he became the CFTC nominee, the former Goldman partner has been slammed for everything from a potential rise in the price of a six-pack to what banks say are unfair efforts to stymie their business.

The pressure isn’t stopping. Gensler and his staff received more than 21,000 public comments on their proposals as of mid-June and have finished only one of the 50-odd rules they’re responsible for. He slogged to Capitol Hill 12 times from December to mid-June defending his agency and asking for money.

“We don’t have the resources to monitor a market seven times the size of futures markets,” he says.

Wall Street isn’t going away. Almost every day, there’s a new objection to Dodd-Frank designed to reduce the law’s impact and keep profits in derivatives markets flowing.

Once a member of the banking elite that talks about generating revenue and maximizing profits, Gensler says he has left that world behind.

“It’s appropriate for people to have different points of view,” he says of the former colleagues and other detractors who have united against him. “My role is to work for the whole economy.”

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