May 15, 2009 3:00 am

Geithner takes big step on Wall Street's road to reform

What does mainstream - or Main Street - America make of Wall Street these days, not to mention the world of derivatives? That is a question I have been mulling this week.

For having just published a book on the financial crisis and derivatives*, I have spent recent days bouncing through dozens of radio and TV stations from New York to Los Angeles to discuss the financial world.

This (admittedly unscientific) survey has revealed at least three things. First - and understandably - ordinary Americans are furious about the incompetence and greed of Wall Street.

Secondly, what makes them doubly angry is a perception that innovations such as credit derivatives have produced no real economic benefit in recent years.

"I don't see anything good in credit derivatives for Main Street America! We should just ban them all!" declared one radio host in Colorado, echoing an oft-repeated view.

Thirdly, to many Americans, men such as Tim Geithner, Treasury secretary, look almost as guilty for creating the current mess as Wall Street bankers. "Why are guys like Geithner still there? They should be kicked out, not put in charge!" I was repeatedly told.

Will this week's initiative from Geithner to clamp down on over-the-counter derivatives do anything to quell this fury? Certainly, in symbolic terms, the reforms mark a watershed.

During the past nine years, Wall Street has operated on the assumption that the 2000 Commodity Futures Modernisation Act had "slammed the door shut" on government OTC controls, as Mark Brickell, a former lobbyist for the derivatives world puts it.

Indeed, the International Swaps and Derivatives Association was so confident that they had won the deregulation debate, that a senior financier once joked to me that ISDA did not need a public relations firm "because we have Alan Greenspan [former Federal Reserve chairman] doing our PR for us."

In reality, Geithner never subscribed to Greenspan's extreme, free-market anti-deregulation views. In public, when Geithner was head of the New York Federal Reserve, he took care not to contradict Greenspan because that would have undercut central banking convention (and, in any case, Greenspan was very powerful then).

In private, Geithner was aware as early as 2005 that free-market self-discipline was not producing rational outcomes, or curbing the wilder excesses of banks - and he was fretting about the opacity of the OTC world.

And this week's announcement suggests that Geithner is now firmly determined to start a new era on his terms. For what this week's announcement essentially represents is not just an effort to reform the letter of the 2000 act; it is also a move to overturn the spirit - and idea that free market discipline alone can encourage bankers to behave.

However, the problem that dogs Geithner - and others - is that while this shift might have great symbolic value and could potentially produce benefits, many of the details of the new measures remain distinctly unclear (as my colleagues point out in pieces on the next page).

Take the case of credit derivatives. Tales are circulating on Wall Street that some unscrupulous traders have been manipulating the price of "single name" CDS contracts to hurt rivals, or make quick profits. It is also claimed that banks have been deliberately trying to push companies into bankruptcy, in locations ranging from Ukraine to the heartland of the US, to profit on CDS positions they secretly hold.

One senior banker, for example, described to me this week how the large Wall Street group where he recently worked had a trading desk that would "pick off" weak companies and hedge funds, by exploiting the murkiness and illiquidity of bilateral CDS deals to push prices around. "It disgusts me, and its still going on," he admitted.

In theory, Geithner's proposals might now curb such abuse by enabling regulators to track many CDS prices and volumes. In that sense, they are progress indeed. But they will not enable investors or companies to know who hold CDS contracts. Nor is it even entirely clear whether the reforms will apply to the more controversial bespoke, bilateral trades.

Whether that matters in the eyes of non-bankers sitting in Arizona, Arkansas or Los Angeles is still unclear. What many bankers now desperately hope is that if the economy bounces back in the coming months, the current sense of outrage among ordinary Americans will soon dissipate - and business will go back to "normal".

Perhaps that will occur. But it seems a bold bet, given that the financial problems have hardly disappeared. Either way, the moral is clear: if Wall Street is to regain respect among mainstream America, it needs to fundamentally rethink how it does business. The Geithner reforms are a good step on that road; they are, however, merely a start. * Fool's Gold, Free Press .

Gillian.tett@ft.com

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