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Investments

Hard proof Dodd-Frank isn't working

The GSEs just got played, big time

January 14, 2014
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Reuters is running a pretty shocking exclusive right now. Apparently the Federal Bureau of Investigation, of all agencies, is investigating the claim that derivative traders are front running swaps orders from Fannie Mae and Freddie Mac.

The article itself goes into the unethical, if technically legal, nature of these trades. So I won't. Still the contents are disturbing in implication.

The first is that the government-sponsored enterprises didn't even look to monitor shifts in markets BEFORE placing these huge orders. Clearly, they were getting played, but aren't even wide awake enough to take notice.

Second, this is proof Dodd-Frank isn't working. The financial reform made plenty to do with how it would regulate derivatives and how this was going to happen: "The Dodd-Frank Act divides regulatory authority over swap agreements between the CFTC and SEC."

Yet the FBI is investigating? Clearly something about this whole ordeal should be illegal, if not yet explicitly so as of today. How did this get past regulatory authority?

After all, we were led to believe that Dodd-Frank is meant to prevent activities just as this.

Three points from the article that show Dodd-Frank isn't working. Read them and weep (the italics are my responses):

1: "Senior bankers at the two banks 'planned and encouraged this behavior because it led to higher revenue for their respective parent banks'."

Dodd-Frank is meant to serve as a model for disincentivizing this exact behavior.

2: There is "low confidence that law enforcement could prosecute suspected traders because the trades concerned seem to be completely legitimate."

This kind of market manipulation may or may not be illegal? Dodd-Frank should have made it clear.

3: "GSEs frequently submit large interest-rate swap trades, making them easy targets for front running and lucrative targets for market manipulation," the FBI bulletin said.

Dodd-Frank has not stabilized threats to the two largest mortgage finance firms in the nation.

It is outrageous that, if this investigation pans out as Reuters indicates, the mortgage finance operations at Fannie Mae and Freddie Mac could be seen as so gullible to this kind of trading.

However, it's the classification of the activity that is even more worrying. The perpetrators employed "unsophisticated tradecraft, such as hand signals and special telephone ring tones." These are not people who are afraid of the law. People behave this way when they think they are above the law.

And if that's not proof Dodd-Frank isn't working, I don't know what is.

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