In the aftermath of the financial crisis, Congress gave federal regulators broad powers to watch over some of Wall Street’s murkiest trades. For years the $600 trillion swaps market operated without supervision and almost entirely hidden from view. Swaps are private agreements that allow investors to either speculate or hedge their risks on interest rates, currencies, and default. In a credit-default swap, for example, the owner of a corporate bond can buy a swap that pays off should the issuer default. These agreements were often negotiated over the phone, with no requirement for either party to post collateral or report the trades publicly. The availability of swaps, which allowed banks to take big risks on bad mortgages in an overheated housing market, was a chief cause of the meltdown.
To keep that from happening again, the 2010 Dodd-Frank financial reform law sought to push swaps trading onto open exchanges, where prices and trading volume could be seen by everyone. That way the government could watch the swaps market in real time, tracking risk and looking for patterns of questionable transactions. After years of writing rules and push-back from the financial industry, the government registered 17 privately owned exchanges, known as swap execution facilities. (Bloomberg LP, the parent of Bloomberg Businessweek, operates one of them.)
But on Oct. 1, the day before the exchanges were to go live, the government shut down. With more than 95 percent of their staff on furlough, top officials at the U.S. Commodity Futures Trading Commission, the federal agency assigned to oversee the swaps market, had limited ability to analyze the flood of data. In the first few days after the platforms opened for business, they recorded roughly $450 billion worth of interest-rate and credit-default swaps; yet in hunkered-down Washington, regulators had to make do with an e-mailed spreadsheet summarizing the previous day’s activity. CFTC Commissioner Scott O’Malia says all he could see was how many swaps had traded, which kinds, and on which of the 17 exchanges the transactions took place. Names, prices, and times were missing. “All I could do was download the files and make some pretty charts,” says O’Malia. “That’s it.”
Now that the government has reopened, the CFTC should finally be able to scrutinize the banks and cry foul at suspicious swaps that could crash the economy, right? Not really. Woefully understaffed, underfunded, and outmatched, the CFTC doesn’t have the tools it needs to keep up with Wall Street. “All the work we’ve done up to now is at risk because we don’t have enough budget resources,” says CFTC Chairman Gary Gensler. “Rulemaking should not be confused with having enough staff or technology to actually oversee the swaps market. To do that, we need hundreds of more people to swim through all this data, to examine it, to answer questions about it, and to ensure it’s accurate.”
In handing the swaps market to the CFTC, Congress gave its biggest, hardest regulatory task to one of the smaller agencies in Washington. Founded in 1975, the CFTC has 672 employees, only 40 more than it did 20 years ago, says Gensler. The money it gets from Congress is less than one-fifth the budget of the Securities and Exchange Commission. Even the newly created Consumer Financial Protection Bureau has a bigger budget and staff. “We envisioned a much more robust agency,” says former Representative Barney Frank, who co-authored the financial reform law. “We gave the CFTC the biggest grant of new authority, and clearly they’ve not been given nearly enough money to do the job. Obviously, we did not anticipate a Republican takeover of the House.”
Money is only part of the problem. The CFTC is largely an agency of lawyers, analysts, and economists who write rules and prepare lawsuits against lawbreakers. Over the past year it’s collected $1.7 billion in fines and penalties from financial institutions and played a lead role in investigating the Libor scandal. To meet its new responsibilities, “We have to transform the workforce,” says O’Malia, the only Republican among the agency’s four sitting commissioners. “We need programmers, people who can interrogate the data and help us get the most out of it.” The head of CFTC’s Technology Advisory Committee, he concedes he’s not yet sure how to get the agency up to speed. “I could not tell you if it’s a machine, or if it’s software or hardware, or how many people that go with it,” he says.
Part of what makes tracking swaps so difficult is that the platforms report the data using different standards (the government didn’t require compatibility), so there’s no easy way for the CFTC to aggregate information about thousands of transactions a day. “We demanded this data,” O’Malia says, “and yet it’s still beyond our reach to understand and use it effectively.”
The CFTC’s budget has risen from $111 million to about $200 million over the past five years, but that’s coincided with a more than tenfold increase in the size of the markets it oversees. The agency already watches over the $37 trillion futures market, another corner of Wall Street the agency has struggled to police. During the past decade, futures have evolved from people shouting and waving paper slips on the floors of exchanges in New York and Chicago to split-second digital transactions where banks, hedge funds, and high-frequency traders speculate on pork bellies, soybeans, and crude oil. Despite the trillions of dollars it monitors and its expansion well beyond farm product futures, the agency is still overseen by the House Agriculture committee.
The agency’s appeals for funds haven’t gone over well. In each of the last three years, President Obama has requested more than $300 million for the CFTC, about $100 million more than Congress has approved. Its budget shrank to $195 million this year because of the automatic spending cuts known as sequestration. “This committee has given them an 85 percent funding increase since 2008,” says Republican Representative Robert Aderholt of Alabama, who chairs the House Appropriations subcommittee in charge of the CFTC’s funding. “So we feel like the money is there for them to do what needs to be done.”
On Oct. 24, Gensler said that due to sequester cuts, he’ll have to furlough staff for as many as 14 additional days in the year ahead. The continuing resolution that Congress passed on Oct. 16 to fund the government through Jan. 15 gives federal agencies the flexibility to move money around to avoid sending people home. Gensler insists he has no such extra cash and says his employees are struggling to keep up with the increasing demands placed on the CFTC. “Every time I ask someone to go dig into the data, they ask me what three projects do I want them to drop,” he says. “We’re stretched that thin.”