The foes of Dodd-Frank financial reform scored a victory recently when a federal court overturned a new rule to limit speculative trading in derivatives.
If allowed to stand, the ruling will leave the economy exposed to continued distortions because derivatives are easily deployed as tools for vast speculation. When the bets pay off, the result is lush bank profits. When they crater, as they did during the financial crisis, the result is bailouts. Either way, Wall Street wins and everyone else loses.
The recent case, brought by trade groups for the banks, was filed against the Commodity Futures Trading Commission, which is charged with writing and enforcing many of the derivative reforms in the Dodd-Frank law. The groups took aim at the C.F.T.C.'s attempt to impose "position limits," or caps, on the number of derivative contracts a trader can hold on commodities like oil, food and metals. The Dodd-Frank law called for caps because without them, excess speculation drives up the prices of gas, food and other everyday products and services.
The industry groups did not dispute the rule on its merits; they said it was invalid because the agency had not followed proper procedures in issuing it. The C.F.T.C. countered that the law explicitly required it to establish position limits and imposed no special procedures. Judge Robert Wilkins of Federal District Court said the law "is ambiguous" on procedural issues and threw out the rule, saying the agency did not have a clear mandate to act.
The defeat is also disturbing because it will embolden banks to challenge other new rules. Commodity derivatives are a relatively small part of Wall Street's derivatives business. Rules to regulate financial derivatives, like credit default swaps, have yet to be completed.
In a welcome move last week, the C.F.T.C.'s general counsel recommended appealing the ruling, and the commission's chairman, Gary Gensler, agreed. But appealing is also risky, since the federal appeals court in Washington, D.C., that would hear the case is notorious for an antiregulatory bias.
For that reason, it also would make good strategic sense for the agency to proceed with reissuing the rules, following the procedures that the banks contend were violated. Though that adds another burden to an overworked agency, it would help to ensure that desperately needed rules will, one way or another, be put in place.
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