Go for it Gary

March 6, 2010

Gary Gensler — regulator and, yes, Goldman alum — has distinguished himself in Washington. As CFTC Chairman, he’s fought to impose stricter rules on OTC derivatives and recently proposed rules that would cut the leverage currency traders are allowed to deploy from 100:1 to 10:1. Lest we all forget how dangerous leverage can be when traders misuse it, there’s LTCM to serve as exhibit A. In a clear sign that Gensler is fighting the good fight, traders are screaming about the proposed rule. Fantastic.

From Carolyn Cui and Sarah Lynch at WSJ: Foes take on leverage curbs from CFTC

An attempt by regulators to protect investors from volatile global currency markets has triggered an uproar among lawmakers, currency dealers and thousands of small traders.

The Commodity Futures Trading Commission has proposed rules that would reduce the amount of borrowed funds that retail investors can use when investing in the U.S. foreign-exchange market to as much as 10-to-1, from the existing 100-to-1 for major currencies.

Under current rules, a customer putting up a security deposit of $1,000 in cash will be able to trade a notional amount of $100,000, a common contract size for currencies such as the dollar and the Japanese yen. The new rule would cap that amount at $10,000.

The rules also would require dealers to abide by new capital and disclosure requirements.

If the rules come into force, investors would be required to either put more capital in their accounts or pare their positions.

Unfortunately, what I’d like to start calling “the politics of easy credit” may get in the way of this sensible new rule:

“If our leverage rules are 10-to-1 and leverage rules elsewhere are 100-to-1, the business is going to move elsewhere,” House Agriculture committee member Jim Marshall (D., Ga.) said.

Thanks Congressman Marshall, for protecting American entrants in the race to the bottom.

As I argued yesterday, on the one hand we want tougher financial reforms, but reforms are related in the sense that they’re all designed to reduce the availability of credit. Call it what you want: leverage, credit, debt finance. Americans love the stuff because it magnifies rewards. The less you put down for an investment — whether you’re a bank, mortgagee or currency trader — the more juice that comes back to you if a trade goes right.

If the trade goes wrong you risk outright collapse, but bet big enough such that your failure is “systemically risky” and you can count on a bailout.

The article notes that the “huge risk-reward potential makes the [forex trading] market a hotbed for scams. From Dec. ’00 to Sept. ’09, more than 26k customers received $476m in restitution in 114 forex fraud cases pursued by CFTC.”

Over 106 months, 114 frauds. Yeah, we’re with Gensler on this one.

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