Big banks are skirting the rules on the sale of the complex financial instruments that helped bring about the 2008 financial crisis, by exploiting a loophole in federal banking regulations, a new report says.
The loophole could leave Wall Street exposed to big losses, potentially requiring taxpayers to once again bail out the biggest banks, warns the report's author, Michael Greenberger, former director of trading and markets at the Commodity Futures Trading Commission.
"We've seen this movie already," he said at a news conference Tuesday.
The regulations cover credit default swaps, a kind of insurance contract taken out by investors to cover potential losses in assets. Such contracts were enormously popular all over the world during the housing boom and led to big losses when the mortgage market collapsed.
Swaps "were time bombs laid throughout the financial system and at the same time they were a conveyor belt that delivered those time bombs throughout the global financial system," said Dennis Kelleher, president and chief executive officer of Better Markets, a group that advocates for financial reform.
"And essentially, this paper talks about how that conveyor belt has been rebuilt by subterfuge, by an industry committed to evading the most sensible, modest and fundamental and necessary protections," he added.
After the 2008 financial crisis, federal regulators approved rules requiring much greater transparency on the sale of credit default swaps, which Wall Street banks strenuously opposed. But a loophole allows banks to evade regulation by offloading the trades to foreign subsidiaries.
Some 90 percent of swaps trades are handled by four big banks — Citigroup, JPMorgan Chase, Bank of America and Goldman Sachs, according to Greenberger.
He argues that rising default levels on consumer and student loans could lead to big losses in the swaps market, similar to what happened a decade ago in the mortgage market. But because much of the trading is done overseas, it's difficult to quantify the potential losses, says Greenberger, who teaches law at the University of Maryland.
Federal regulators were attempting to close the loophole at the end of the Obama administration, but the Trump administration appears to have abandoned the effort, he adds.
The CFTC declined to comment on the report, which was published Tuesday by the Institute for New Economic Thinking, a left-leaning think tank.
The International Swaps and Derivatives Association, which represents the derivatives industry, released a statement taking issue with the charge that traders were seeking to evade regulation.
"The issue raised in the paper is not new and has been discussed extensively," the group said. "It seems clear that the paper is designed to rehash old criticisms and ignore the very real progress that has been made in increasing the resilience, transparency and safety of global and US derivatives markets."
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It's been a decade since the financial crisis that devastated the global economy. In the years that followed the collapse, Congress and federal regulators drew up rules to rein in big banks and prevent another crisis. A report out today says banks have found a loophole around some of those rules, and it warns that taxpayers could be on the hook if the economy takes a bad turn.
NPR's Jim Zarroli has been digging into this. He joins us now. And, Jim, the 2008 crisis was caused by a lot of complicated financial investments. So is this what the report is focused on?
JIM ZARROLI, BYLINE: Yes. Yes. Let's say you own some kind of investment, and you're worried that it might lose value. One way that you can protect yourself is by buying something called a credit default swap. Now, this is one of those really complex Wall Street products that works like - it works like a kind of an insurance contract. You can even buy these contracts on someone else's investment.
And that's exactly what a lot of investors did in the years leading up to the crash. They placed bets on assets owned by other people, especially on mortgages. The market for those products was huge. It was in the trillions of dollars. So when the mortgage market tanked, there were just enormous losses, and they dragged the global economy down. And after that, Congress came in and set up a lot of new rules to govern these swaps. Wall Street didn't like them because Wall Street makes a lot of money off of selling these products.
CORNISH: Now a report says Wall Street has found a loophole in the rules. Can you give us a little bit more background in the study itself in terms of who did it? And what do they consider a loophole?
ZARROLI: Well, this is based on research by Michael Greenberger of the University of Maryland. During the Clinton administration, he was with the agency that regulates these contracts called the Commodity Futures Trading Commission. Greenberger says all of this comes down to a single footnote in the regulations - you know, the kind of footnote that most people don't ever read. It essentially says the regulations don't apply if the products are traded overseas. And Greenberger says the banks interpreted this to mean that they could, you know, slough these trades off to their foreign subsidiaries.
CORNISH: So wait a second. You're talking about swaps overseas. Why would that be a problem for U.S. taxpayers?
ZARROLI: Well, it comes down to a question of who's on the hook. I mean, remember; after the financial crisis, U.S. taxpayers had to bail out the banks for losses. The banks are saying that won't happen again this time because these - you know, these - swaps are traded overseas, so U.S. rules don't apply. But Greenberger says that's a fig leaf because even though a foreign subsidiary will be doing the trades, these are still U.S. banks, so U.S. taxpayers will have to bail them out.
CORNISH: The U.S. economy seems to be doing fairly well right now. How much should we really be concerned about this?
ZARROLI: Well, we don't really know how big a problem this is. Greenberger says a lot of these trades - you know, we just don't know that much about how many there are. But the former Fed Chairman Paul Volcker appeared at a press conference today to talk about this report. And he says history really shows us that these problems have a way of festering, and then all of a sudden, you have, you know, a really big problem on your hands.
(SOUNDBITE OF PRESS CONFERENCE)
PAUL VOLCKER: What strikes me is I've seen it all before...
VOLCKER: ...Over and over again in different degrees of complication.
ZARROLI: So federal regulators are aware of this loophole. They've been working on this before. Under the Obama administration, there was an effort that took some time to try to tighten it. I reached out to the Commodity Futures Trading Commission today to find out what's going on with that, but they declined to comment.
CORNISH: That's NPR's Jim Zarroli. Jim, thank you.
ZARROLI: You're welcome. Transcript provided by NPR, Copyright NPR.