As the Obama Administration budget was announced today, the Commodity Futures Trading Commission (CFTC) seems to be the agency left out in the cold at a time when regulating over the counter derivatives (OTC) has been identified as a key strategic economic concern.  With between $400 and $600 trillion in previously unregulated derivatives, a significant market crash could literally wipe out the world economy, valued at just over $70 trillion.

CFTC

In the budget proposal, the Securities and Exchange Commission (SEC) was allocated $1.7 billion, representing a slight increase over what had been anticipated.  By contrast the CFTC was allocated $280 million, down $35 million from what they had requested. While the Obama budget proposal is significant, it should be noted the real power to appropriate government spending lies in the Republican controlled House of Representatives.

Amidst credible warnings of derivatives implosions, cutting CFTC budget could be a trigger point for next crash

“Dodd-Frank was passed in reaction to the 2008 economic collapse,” outgoing CFTC Democratic Commissioner Bart Chilton said. “I wonder if some forget why the meltdown occurred and what is needed to secure solid footing. Even during a time of deficit, our country must do all it can to avoid a repeat of what led to the economic mess.”

As noted in numerous ValueWalk articles, some of the largest hedge fund players in the world have predicted a derivatives implosion and noted with alarm what is viewed as “financial lawlessness” on Wall Street. With this as a backdrop, why is the CFTC, the cop on the beat protecting the American public, struggling to obtain funding?

Powerful Wall Street bank lobby opposes derivatives regulation

“The large derivatives dealing banks have opposed derivatives regulation every step of the way,” said Lisa Donner, executive director of Americans for Financial Reform. “One way to oppose derivatives regulation is to prevent the CFTC from being funded.”

Derivatives regulation has always been a contentious issue, dating back to the late 1990s when then CFTC chairwoman Brooksley Born fought a lonely battle against the largest banks.  When she requested transparency into the unregulated derivatives, warning that they would ultimately implode, she was forced from office by the powerful Wall Street bank lobby.  The derivatives she warned of ultimately imploded in 2008, sending the US economy into a tailspin from which it has been unable to fully recover. She has since warned of another derivatives implosion, yet the largest banks’ exposure to derivatives has only grown larger, along with their profits and political power.

“The White House must not wave the white flag of surrender on derivatives reform and abandon the financial regulators at their time of need, which is right now.” said Dennis Kelleher, President of Better Markets, a nonprofit organization that promotes the public interest in the financial markets.  “Reports that the White House budget is going to slash its request for funding for the CFTC by more than 10%, from an already grossly inadequate $315 million to just $280 million for an agency with responsibility for markets larger than $400 trillion, is wrong by every measure and a disservice to the American people. It is bad policy, politics, economics and sends the wrong message.”

CFTC is like Cinderella – they clean up the mess while their siblings attend the ball in grand style

The CFTC is said to have fallen behind other regulators in both pay and benefits. An internal CFTC report, reported in Bloomberg, noted that pay at the CFTC was 7% less than pay at the SEC, which also enjoyed additional fringe benefits. As President Obama gave federal employees a 1% raise to start the year, employees at the 700-person CFTC were not given the increase, according to the report. According to the Partnership for Public Service, an organization that monitors federal employees, the CFTC ranked the sixth worst place to work of 29 small US government agencies.

The resulting lack of compensation and benefits has resulted in a significant brain drain at the agency at a time when derivatives threaten the world economy.  While many CFTC employees are leaving, those that remain are discussing unionizing, according to the Bloomberg report.

“Our staff is on its knees, some reaching for the exit doors and others already having bailed. Employee morale is the lowest I’ve witnessed,” Chilton said.

Disrespect shown to important derivatives regulator generates outrage

The nearly 20 year fight to regulate derivatives that have demonstrated the potential to destroy the economic foundations of an advanced society has generated a divide.  On one side is the most well-funded lobby group in US history against a small but passionate group that fights for derivatives regulation to protect the American public. “Wall Street and its political allies have fought nonstop for years to make sure the financial regulators were not fully funded to cripple them so that they could not properly police Wall Street,” Kelleher of Better Markets said. “They are protecting Wall Street profits at the expense of Main Street jobs. President Obama and his administration have fought against this and must not retreat now.”

Perhaps most confusing is why the Obama administration budget proposal would lavish the SEC but ignore the derivatives regulator at this key moment in history.

“To require the CFTC to… regulate derivatives markets, police Wall Street and prevent another financial crash, but to deprive them of adequate funding, is to set them up for failure and criticism. That is a huge win for Wall Street’s biggest, most dangerous banks, but a loss for everyone else. The CFTC and all the financial regulators must be fully funded now and the President must fight for that,” Kelleher concluded.

The one potential silver lining for those favoring independent CFTC funding are a few little noticed yet powerful lines.  The Obama administration left in their proposal a provision that would allow independent funding of the CFTC through a transaction tax, but even this is not entirely seen as serious because a full legislative proposal would be required, which was not forthcoming from the Obama administration.  Chilton had favored this proposal and recommended it to the president, but it is opposed by the major exchanges and high frequency traders and its passage is unsure.