Banking Reform We Need but Won't Get

On Friday, Senate Banking Committee Chairman Christopher Dodd (D., Conn.) announced he had given up on trying to craft a financial reform bill that would win any Republican support. Sometime today he will present his own idea of what banking reform should look like.

Because Dodd couldn't secure a compromise, we know that the bill will look draconian to one side of the aisle and will be fought tooth and nail by the very powerful banking lobby. It won't pass. It can't pass. So, let me be first to say it: No matter what Dodd comes out with, it won't go nearly far enough.

Only Paul Volcker's plan of a full reinstatement of Glass-Steagall firewalls between banking divisions is worthy of the partisan argument we will have to endure, no matter

what

reform bill is proposed. Since reappearing on the scene, the grandfatherly Volcker has as much as disappeared, as it's become unfortunately clear just how little chance the "Volcker plan" has of being enacted.

The Dodd Bill is Not Enough

The safeguards brought into being with the banking act of 1932, collectively known as Glass-Steagall, kept our markets safe from cataclysmic destruction for nearly 70 years.

The watering down of regulation and ultimate repeal of the act in 1999 opened the floodgates to banking consolidation that brought the lenders under the same roof as the investors.

The proliferation of over-the-counter derivatives and the ability of banks to sell and proprietarily trade these instruments led to 30-to-1 or 40-to-1 leverage and bets on everything -- from real estate, to corporate debt, to oil, to even the solvency of sovereign nations, as we have recently seen in Greece.

Two central problems need to be addressed by banking reform, and they will require some serious legislation from some serious people.

First is the problem of "too big to fail." With so much of the economy's capital engaged on the trading books of a few dominating banks, how can you ignore any blowup, no matter how small it may look, in any capital market?

Lehman Brothers

proved just how deeply interconnected all the institutions are, as that one failure brought the world's credit markets to the brink and inspired the most massive capital injection in history just to keep the system alive.

No. 1 on my list of reforms that have no chance of happening: It's time to break up the banks. All of them. And go back to the Glass-Steagall division between lending and investing.

Second, the unfathomable $600 trillion over-the-counter derivatives market must be brought under control. In my continuing list of reform ideas that will never, ever happen, every one of these markets must be migrated into federally regulated exchanges for open trading and clearing. This is the only path to real transparency. If it can be standardized, it can be brought onto an exchange.

If it can't be standardized, it needs to be retired. An old, and rarely used, futures market "trick" to retire contracts that needed to go was a "cash settlement." One morning, the settlement prices would be generated, everyone with a position settled up for cash and the entire contract was finished. Done. Over. You'd get some grousing, and you'd need the financial equivalent of King Solomon to generate fair settlements. But who really needs these gargantuan complex instruments? We apparently did just fine without them before 2000. It is clear who has benefited most from their unregulated, unmonitored growth.

Here's the point: Derivative markets represent only risk transference -- in other words, bets -- that create nothing and don't swing the total capital pool either way. All derivative markets are a zero-sum game.

You could retire an enormous percentage of these

tomorrow

with a lot of money changing hands, but no overall change in the capital pool. The body remains whole, and is made stronger by the removal of systemic risk to the markets. That's No.2 on my list of reforms that will never happen.

But I am looking forward to seeing the relatively benign proposals that Senator Dodd puts forth today. Whatever little he proposes has a slim to zero chance of passing through this partisan congress.

And slim left town a while ago.

-- Written by Dan Dicker in New York

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Dan Dicker has been a floor trader at the New York Mercantile Exchange with more than 20 years' experience. He is a licensed commodities trade adviser. Dan's recognized energy market expertise includes active trading in crude oil, natural gas, unleaded gasoline and heating oil futures contracts; fundamental analysis including supply and demand statistics (DOE, EIA), CFTC trade reportage, volume and open interest; technical analysis including trend analysis, stochastics, Bollinger Bands, Elliot Wave theory, bar and tick charting and Japanese candlesticks; and trading expertise in outright, intermarket and intramarket spreads and cracks.

Dan also designed and supervised the introduction of the new Nymex PJM electricity futures contract, launched in April 2003, which cleared more than 600,000 contracts last year alone. Its launch has been the basis of Nymex's resurgence in the clearing of power market contracts over the last three years.

Dan Dicker has appeared as an energy analyst since 2002 with all the major financial news networks. He has lent his expertise in hundreds of live radio and television broadcasts as an analyst of the oil markets on CNBC, Bloomberg US and UK and CNNfn. Dan is the author of many energy articles published in Nymex and other trade journals.

Dan obtained a bachelor of arts degree from the State University of New York at Stony Brook in 1982.