photo: DragonFlyEye via Flickr)

photo: DragonFlyEye via Flickr

Jamie Dimon, CEO of JP Morgan Chase, says that he can be trusted to trade derivatives, like interest rate swaps and credit default swaps, without bothering with exchanges and clearinghouses.

“There should be room for over-the-counter — you always read about they don’t have capital, they’re not regulated, and all of that is just untrue,” Mr. Dimon said.

“Over-the-counter derivatives, if you were doing it through a broker-dealer which is regulated by the O.C.C. and Fed, have capital requirements and credit reporting requirements, and we think it is important that that business be allowed to exist to service customers properly,” he said.

What Mr. Dimon doesn’t say is that this is exactly how we got into trouble with these miserable things, relying on the capital structures of insurance companies to back up their credit default swaps. It didn’t work for AIG, and there isn’t any reason to think it will work for any of the other regulated entities whether or not they are too big to fail. The capital structures of even giant brokers couldn’t withstand the financial shocks of 2008, and threatened the nation with another Great Depression. I don’t think much of the Office of the Comptroller of the Currency either.

I’ve been trying to find an explanation of the benefits of swaps that would justify the risks they create. Yves Smith at Naked Capitalism poses the question in great detail here, and her knowledgeable commenters have no clear explanation of the value, and offer no evidence that the benefits are greater than the risks.

My favorite explanation is from Goldman Sachs Managing Director E. Gerald Corrigan: credit default swaps enable us to short bonds and bank loans. This is just not impressive, but Mr. Corrigan will laugh all the way to the bank with his share of the $23bn bonus pool at GS.

The original draft of the bill to regulate derivatives in Barney Frank’s House Financial Services Committee had a very limited regulation for derivatives, and contained a number of exemptions. Bloomberg says that amendments offered by Congressman Frank and others will reduce the exemptions and bring the bill closer to the proposals of the Administration. Unfortunately, some of the more stringent restrictions were dropped. One of these would have given regulators authority to outlaw “abusive” swaps. Why cut that?

“There was concern that a broad grant to ban abusive swaps would be unsettling,” Frank said.

Those banksters like what they call “bright-line” rules. It is torture for them to have to define hard words like “fraud” or “misleading”. It’s like the word “torture” itself, just too hard, and not at all intuitive, so complex we have to have John Yoo to define them. “Abusive” is apparently just as difficult to understand. The old rule, before St. Reagan, was to use words that have a common meaning in law and practice, and let regulators and courts enforce them. That is a battle the anti-regulation forces won, and they won’t give it up without a fight.

It doesn’t matter how much you reduce regulation, Republicans were concerned, deeply concerned, to the point of trolling:

“I continue to be fearful that at every single step we’re making the use of derivatives more costly, more cumbersome,” said Representative Jeb Hensarling, a Texas Republican.

To me, making the use of derivatives more costly and cumbersome is a good thing, especially if it reduces them from the current level of $592 trillion (Bloomberg’s number). What I’m fearful of is that the 98% of Americans who don’t know what a swap will be left to the good will of Mr. Dimon and his ilk, whose track record is losses in the range of trillions of dollars as the result of their incompetence at risk management.

Update: David Dayen has an news of Financial Services Committee action, and a statement from Americans for Financial Reform.