The Center for Public Integrity

Gary Gensler, the top regulator of the commodities markets, sees the U.S. financial system still “vulnerable” to the murky world of privately negotiated derivatives.

As chairman of the U.S. Commodities Futures Trading Commission (CFTC), Gensler wants to comprehensively oversee the trading of these complex financial contracts for the first time.
 
While some forms of derivatives are traded on regulated exchanges, federal regulators including Gensler, who was appointed by President Obama in December, have almost no power over derivatives that are traded privately on the phone or electronically. This over-the-counter derivatives market, which internationally is valued at nearly $600 trillion, is blamed for compounding the current financial crisis.

“We stay particularly vulnerable because we haven’t filled the [regulatory] gaps,” Gensler told the Huffington Post Investigative Fund in an interview this week. 

Although derivatives are intended to hedge risk or act like insurance on an underlying asset, they also can be used to speculate on prices. Credit default swap derivatives, some of which insured toxic mortgage-backed securities, drove the financial tailspin of the insurance giant AIG.

Since last year’s calamity, the nation’s five largest commercial banks have become even more exposed to derivatives, to the tune of almost $200 trillion, according to a recent report by the U.S. Comptroller of the Currency.  Those five banks — JPMorgan Chase, Goldman, Bank of America, Citibank and Wells Fargo — hold about 97 percent of all derivatives in the U.S. banking industry, the report said.

Before the housing boom got underway in the late 1990s, a California nonprofit group hatched an idea to help families who qualified for government-backed mortgages but still couldn’t raise the down payment. 

A home builder would agree to make a donation to the nonprofit in an amount equal to the down payment. The nonprofit would give the cash to the buyer, often earning a generous fee for its role as middleman. In less than a decade, nonprofits had arranged more than a million no-money-down house sales around the country. By 2008, they represented more than a third of all loans backed by the Federal Housing Administration. 

Now many of those loans have gone bad. Defaulting at up to three times the rate of other FHA loans, they are one reason the housing agency’s insurance fund is about to drop below its required capital level for the first time since it was created during the Great Depression. 

Congress last year stopped the FHA from insuring any more of the loans, saying they were risky and carried the potential for fraud and abuse. One case in July confirmed those concerns: As part of a settlement of criminal charges in U.S. District Court in North Carolina in July, Beazer Homes USA Inc., acknowledged that its employees had defrauded buyers by simply rolling the extra cost of the down payment assistance into the house price. 

Little attention has been paid to the role of the down payment programs in the origins of the financial crisis. Government and court records examined by the Huffington Post Investigative Fund illustrate how two large housing nonprofits – Nehemiah Corporation of America and AmeriDream Inc. -- worked closely with the mortgage divisions of the nation’s biggest home builders, adding fuel to the housing bubble and in effect paving the way for even riskier subprime loans by private lenders.