Hate derivatives? How can you like cap-and-trade?

Bob Tippee
Editor

Political gyrations over financial and energy reform camouflage a wicked hypocrisy.

Financial reform legislation in the Senate treats derivatives as demonic. Derivatives are tradable financial instruments linked to physical commodities. Some are traded on centralized exchanges subject to regulation, others less formally in a hazy realm known as “over the counter” (OTC).

OTC derivatives receive much of the blame for the financial system’s unraveling in 2008.

Reform legislation would require that many derivatives now traded OTC instead be traded on regulated exchanges.

Attention to derivatives, with the purpose of tightening regulation of them, no doubt is in order. But the pressure on Congress to overreact is strong. Financial industry representatives say the Senate legislation goes too far.

Indeed, senators are just acting in character if they’re using derivatives as a scapegoat. They’d like voters to forget their own roles in the financial crisis, such as encouraging imprudent mortgage lending.

To crack down on existing derivatives while creating another one, moreover, seems wildly inconsisent.

The new derivative would be the tradable emission credit central to cap-and-trade systems for managing greenhouse gases.

Legislation passed by the House made emissions trading its centerpiece. The Senate has been wary of the House approach and may be in no mood to take up climate-change legislation before elections in November.

But Sens. John Kerry (D-Mass.), Lindsey Graham (R-SC), and Joe Lieberman (I-Conn.) have written a bill that retains the cap-and-trade approach at least for utilities.

Prospects for their proposal are cloudy. While many senators don’t want to address the issue now, supporters of aggressive climate-change responses think now may be their best chance to ram a bill into law.

The push lost momentum when Graham threatened to withhold support after Senate Majority Leader Harry Reid, in what many see as an act of political opportunism, made immigration reform his priority.

Political intrigue thus diverts attention from questions about a tradable financial instrument anchored to a license to emit greenhouse gases, the value of which would be determined by the government.

As derivatives go, nothing in existence now is more deserving than that of suspicion.

(Online Apr. 30, 2010; author’s e-mail: bobt@ogjonline.com)

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