The Secretive Men of ICE

Apart from the sinister specter of socialism, the most common complaint raised against increased federal oversight of our financial markets is that it empowers aloof bureaucrats to “pick winners and losers” on Wall Street, and therefore defiles the essence of free-market competition.

But as Louise Story makes clear in a New York Times dispatch from the arcane battles over disclosures in the derivatives market, the real reason that investment banks resent government intrusion is that is too much, rather than too little, competition. They believe that picking winners and losers is clearly their job. Storey gamely tries to report on the doings of a nine-member conclave of New York-based banking executives that operates without any public mission statement, reports of its doings, disclosure of trader fees, or even official confirmation of the members’ identities.

Derivatives traders insist that they need all this secrecy to reinforce the central role of derivatives trades: to hedge investors against risk in market transactions that could leave their investments exposed to destabilizing price fluctuations. The nine bankers are members of a risk committee, which meets under the aegis of the InterContinentalExchange (ICE) Trust. That body functions under the new financial reform law as what’s known as a derivatives clearing house — a deceptively open-sounding moniker for a group sharing a monastic devotion to keeping its activities as far from plain sight as possible.

As Story notes:

In theory, this group exists to safeguard the integrity of the multitrillion-dollar [derivatives] market. In practice, it also defends the dominance of the big banks.

The banks in this group… have fought to block other banks from entering the market, and they are also trying to thwart efforts to make full information on prices and fees freely available.

Nor does the secrecy stop there. As investigative reporter Lucy Komisar writes, the ICE consortium was founded two years ago as an offshore concern in anticipation of the 2010 financial reform law. It keeps its corporate brassplate in the Cayman Islands, and many of the biggest players in the derivatives market sit on its board, including Morgan Stanley, Goldman Sachs, Citigroup and Bank of America. “ICE focuses on the market for credit default swaps, a form of insurance that protects investors against defaults in the bond market,” Komisar writes. “ICE’s member banks account for about 90 percent of the credit default swap market and are thus in position to steer business to ICE and help it capture a leading market share.”

With such an enormous shared stake in overseeing the US derivatives market, why should ICE be incorporated in the Caymans? The company itself won’t say, not surprisingly, but it’s a safe bet that it’s headquartered there for the same reason that most other offshore concerns land on the Caribbean atoll: to evade American tax law. US regulators treat the security deposits that most derivatives traders collect on their trades as loans, and the proceeds of them are therefore taxable once they’ve completed their heady runs through global trading markets and are repatriated within American borders. Like many such holding operations, the ICE Trust is perfectly legal — but its perch atop the emerging regulatory structure of the derivatives market doesn’t exactly inspire confidence that we are on the verge of a new age of financial transparency.

Nor, as Story observes, does the apparent membership of the ICE risk committee (two sources confirmed the lineup of big-ticket investment bankers to her, even if ICE itself would not) suggest that conflict-free oversight of the roughly $60 trillion global derivatives game is the committee’s prime directive. Some risk-committee members sit on the boards of the other two clearinghouses, run by the Chicago Mercantile Exchange and NASDAQ, and some serve on the International Swaps and Derivatives Association, which sets the rules for global derivatives trades. Small wonder that a Justice Department spokeswoman tells Story that federal prosecutors are looking into “the possibility of anticompetitive practices in the credit clearing, trading and information services industries” — and that the Justice probe is one of the seemingly limitless list of subjects that ICE and the other two clearing houses offer no public comment on.

When backers of the ICE risk committee can be prodded into public speech, they say that the group is so reclusive because the stakes of its operations are so high — and that it can’t invite other market players to sit in because they can’t meet the forbidding capitalization requirements for membership. (No, they won’t disclose that number either, but trust them — it’s big.)

The grand irony in all this, as Story notes, is that the opaque, offshore ICE operation was conceived as an instrument of financial reform, hectically executed on behalf of the regulators putting the legislation together before the toxic deals in the housing sector spread further across the vast derivatives market.

And it’s not as if the take-charge committeemen for ICE had to be schooled in keeping their traps shut. The entire derivatives market is set up to maximize secrecy, as that’s the essence of its fee-and-profit-making model:

In most cases, buyers are told only what they have to pay for the derivative contract, say $25 million. That amount is more than the seller gets, but how much more — $5,000, $25,000 or $50,000 more — is unknown. That’s because the seller also is told only the amount he will receive. The difference between the two is the bank’s fee and profit. So, the bigger the difference, the better for the bank — and the worse for the customers.
It would be like a real estate agent selling a house, but the buyer knowing only what he paid and the seller knowing only what he received. The agent would pocket the difference as his fee, rather than disclose it. Moreover, only the real estate agent — and neither buyer nor seller — would have easy access to the prices paid recently for other homes on the same block.

And of course, since the underlying assets in most derivatives trades are basic commodities like fuel and food, this speculation can wreak havoc on ordinary consumers’ cost of living even as it handsomely bulks up the traders’ bottom lines. Derivative swaps were what permitted the brave new traders at Enron, for instance, to cut off power to California homes during the early-aughts wave of blackouts there — and use the artificial scarcity to keep driving up their fees. Derivatives speculation was likewise the driving force behind the punishing 2008 spike in oil prices — even as global demand for oil dropped by 5 percent that year.

So yes: Welcome to the new era of Obama-engineered financial reform. As with the White House’s kindred capitulations on tax cuts for the rich, there’s little for the rest of us to do but await the inevitable moment when we pick up the check.

Chris Lehmann is the author of Rich People Things.