House panel votes to rein derivatives

A House panel voted Thursday to regulate for the first time privately traded derivatives, the kind of exotic financial instruments that helped bring down Lehman Brothers and nearly toppled American International Group.

The 43-26 vote by the House Financial Services Committee was a first major step for President Obama’s plans to overhaul federal regulations governing the nation’s financial institutions.

The mostly party-line vote showed that Democrats were prepared to band together to override objections by Republicans and the financial lobby and demand increased oversight of Wall Street.

No Democrat on the panel opposed the measure. One Republican, Rep. Walter B. Jones of North Carolina, sided with them to approve it.

Next week, the panel is expected to approve another big piece of the Obama regulatory plan that would create a federal agency dedicated solely to protecting financial consumers. Both measures would still face scrutiny by the full House, as well as in the Senate where business-minded Republicans are likely to wield more influence.

But for now, the administration is hailing Thursday’s vote as a critical step toward throwing sunlight on an opaque and growing $600 trillion global market.

The bill ?is absolutely essential to preserving a strong marketplace, preserving transparency [and] getting incentives right in the system,? said Michael Barr, Treasury’s assistant secretary for financial institutions.

?We don’t want to allow any firm like an AIG to be able to engage in derivatives transactions without requiring those transactions be reported and to be traded on an exchange,? he said.

In the case of AIG, the company sold a form of derivatives, called credit-default swaps, to investors who were looking to protect themselves against losses in the housing market. When home defaults rose, AIG didn’t have enough resources to make good on all of its promises and required a hefty government bailout to avoid folding.

The government had been taken off guard by the extent to which AIG was over-leveraged because regulators weren’t monitoring the contracts and could only guess at the size of the general derivatives market.

Under the proposed bill, AIG would have to conduct those transactions on a monitored exchange and prove to federal regulators that they had sufficient reserves to back them up.

Democrats included an exemption for companies that use derivatives to protect against risk. The exemption was intended to distinguish between AIG and other financial institutions that use derivatives to make money, and manufacturers that rely on them to protect against a spike in fuel prices or fluctuating exchange rates.

Companies could lose that exemption if regulators see a pattern of activity that places other participants in the transactions at risk. Exempt or not, companies also would have to report their trades and the prices.

?There will be no more hidden trades where we don’t know the price,? said Rep. Barney Frank, the Massachusetts Democrat who chairs the panel.