An Ex-Goldman Man Goes After Derivatives

How a former Goldman partner became Obama's toughest derivatives regulator

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Commodity Futures Trading Commission Chairman Gary Gensler speaks during a hearing of the Senate Agriculture, Nutrition and Forestry Committee on Capitol Hill November 18, 2009 in Washington, DC.

The first time Gary Gensler met with an elite group of Wall Street moguls in a private room at the Willard Hotel, they did not pay him any mind. He was just an Obama-campaign envoy seeking support from CEOs. "I don't think I will be able to stick around," Goldman Sachs boss Lloyd Blankfein said just as Gensler arrived.

Times have changed. When Gensler met the group again a few weeks ago as the head of the U.S. Commodity Futures Trading Commission, the lords of finance sat up straighter in their chairs. Wall Street no longer goes to Washington to dictate terms; it goes to beg for mercy (and to rally its lobbyists). The meeting, scheduled for 45 minutes, lasted 75. And the CEOs of JPMorgan, Goldman Sachs, Wells Fargo and Fidelity, Gensler recalls, "never left the table."

The reason for Wall Street's new alertness is the same as ever — money. Even before Goldman Sachs faced charges of fraud for its deals, derivatives regulation — once a technical Washington backwater — had moved to the center of Democratic efforts to curb Wall Street's worst financial excesses. In mid-April, President Obama threatened a veto if the new regulations "do not bring the derivatives market under control." Treasury officials began briefing reporters on the attempts of bank lobbyists to create loopholes. The derivatives party, which has been under way for years, is coming to a close.

But while other officials have only lately called for reform, Gensler has been sounding the alarm for months. His tiny and obscure agency is slated to get vast new regulatory authority over big banks. Since September, Gensler, a former Goldman Sachs partner, has given more than 40 speeches about these complex contracts that allow banks, investors and corporations to bet on future events, explaining the central role they played in the financial crisis. Taxpayers have already had to pony up $180 billion to pay off bad bets made by insurance giant AIG. "That means that every person in this room has $600 in AIG," he tells audiences wherever he speaks.

Gensler knows that many of the big banks see the coming reforms as a direct assault on their profits. According to the Comptroller of the Currency, U.S. banks made $23 billion from derivatives trading in 2009, with the five largest institutions conducting 97% of the domestic bank deals.

Only the banks knew the true cost of these trades, allowing them to bring in huge profits that they say could evaporate if trading is forced out of the back rooms and onto public exchanges, as Gensler is proposing. Jamie Dimon, the head of JPMorgan, has estimated that new transparency could strip $700 million to $2 billion in annual receipts from his bank alone. Gensler, for his part, explains that the banks want to keep the deals private so they can profit from knowing more about the going price for every derivative — for home loans, interest rates or anything else — than those who would buy and sell them. "Information," Gensler explains, "is money to Wall Street."

The banks have rallied a vast army of lobbyists to water down the legislation as it passes through Congress. That seemed to work last year, when House Democrats endorsed a reform package that exempted a large share of derivatives from regulation. But something strange happened this spring, as the cherry blossoms bloomed around the National Mall. The banks lost their grip on Congress, and two committees that had ignored the derivatives problem for years pushed tough new reform bills to the Senate floor. Those measures would not only require transparent trading but also create new clearinghouses to make sure all murky bets were paid off no matter what happened to the markets.

That was largely the vision Gensler sketched out more than a year ago when he signed on with Obama. As the head of a regulatory body that traditionally oversees farm and commodity futures, Gensler felt free to take the lead in the fight for tougher derivatives regulations than even the Administration at first proposed. Gensler is a little like the safecracker who goes to work for the cops. Born and raised in Baltimore, where he still lives, he spent 18 years at Goldman, making partner at the same time as its current CEO, Blankfein. Gensler retired in 1997 to join the Clinton Treasury team, where he agreed with his colleagues who argued against derivatives regulation. That's a position he now largely disavows. "I think we all evolve," he says. "In Washington, so often people don't like to admit that."

Thanks in part to Gensler, it is now Wall Street's turn to do some evolving.