By Sen. Saxby Chambliss (R-Ga.) - 06/15/10 11:26 PM EDT
During this debate, “derivatives” have been misunderstood and mischaracterized. Derivatives are simply financial instruments with a price derived from the value of underlying assets (interest rates, commodities, securities, etc.), and are used by almost every industry in this country to hedge business risks.
While most in Congress recognize the legitimate use of derivatives, some seem to believe that businesses should be forced to pay more for using these tools – in the form of margin paid to a clearinghouse – by requiring most derivatives transactions to be cleared. Today, many transactions are conducted bilaterally among individual buyers and sellers that do not involve a clearinghouse.
As we explored the evolution of the financial crisis, we found that many financial dealers and entities, such as AIG, were holding large uncleared derivative positions, which increased their vulnerability during unfavorable conditions. Congress properly determined that moving more of the derivatives held by these systemically risky institutions into a clearinghouse would relieve pressure on the financial system.
However, forcing businesses that are not contributing to systemic risk to move their derivatives through a clearinghouse has several negative economic effects: Companies that are required to cover these margin costs will pass them along to consumers; companies in capital-intensive industries will be forced to raise and tie up additional capital that would otherwise be available to hire workers; and some businesses that cannot pass on their costs or raise additional capital will simply quit using derivatives to hedge business risk or go offshore to do the same transaction.
There are real-life examples of these negative effects of clearing requirements everywhere: The Municipal Gas Authority of Georgia estimated that a clearing requirement would increase costs by approximately 25 cents on every MMBtu delivered – a 10 percent increase in distribution rates – to its 243,000 customers in Georgia, Alabama, Florida, Pennsylvania and Tennessee. Numerous practical examples can be given and they all translate into one thing – job losses.
Requiring businesses that provide credit to our nation’s producers (like the Farm Credit System Banks or John Deere Credit) to clear their interest-rate derivatives will result in higher interest rates being charged to our farmers, ranchers, electric cooperatives and renewable fuel facilities for business and equipment loans.
The Senate passed a bill that tried to alleviate this burden on some end users. But it is too limited and misses the mark. It applies an overly complicated, confusing standard on many businesses that will be forced to clear their transactions without doing anything to make our financial system less risky.
I fear the unintended consequences resulting from applying complicated, one-size-fits-all regulations too broadly will subject our American businesses to more risk, not less, and will result in consumers paying more for goods and services.
Let’s be clear: Risk does not disappear in a clearinghouse. It is simply transferred from the individual counterparties of the derivatives transaction to the clearinghouse. Clearing mandates designed to address the systemic risk should be applied only to those businesses that are systemically relevant; businesses that do not contribute to this type of risk should not be required to comply with regulations designed to provide relief from a crisis they did not create.
Mandatory clearing of derivatives could drain the economy of about $700 billion in capital. The key to job creation and economic recovery starts with strong businesses with capital resources, not economically harmful limits on capital availability and risk-management options.
If my colleagues are truly interested in “restoring American financial stability,” as the title of this legislation suggests, we should ensure the application of derivatives regulations on Main Street businesses are necessary and appropriate. As a member of the conference committee, I hope we are provided the opportunity to address this and several other shortcomings of this legislation before it is signed into law.
Chambliss is the ranking Republican Member on the Senate Committee on Agriculture, Nutrition and Forestry.