I am motivated by much more than pride of authorship in my concern that the Republicans will carry out Sen. Mitch McConnell’s pledge to undo the financial reform we adopted after the recession caused by the lack of regulation. One item on his agenda – the repeal of restrictions on derivative trading – threatens our financial stability.

Derivatives have a long and useful history, allowing people who produce goods or services to protect themselves against price fluctuations. Airlines need to use derivatives to protect against wild swings in the price of fuel. Farmers have been prominent in need of this protection, given the cyclical nature of agricultural markets. (That is why before 2010 the only federal entity that had any responsibility for regulating derivatives was the Commodities Futures Trading Commission.)

The financial crisis was caused in part by the creativity with which large financial institutions applied the derivative form to purely financial transactions. The precipitating cause of the crisis in 2008 was when officials from the insurance company AIG came to the Bush administration to confess that it had incurred obligations through its sale of credit default swaps – a form of financial derivatives – which they could not meet. In fact, they first told the Federal Reserve that they were $85 billion short. A week later they had to double that figure. Not only did they not have the funds to meet the obligations they had incurred, they had no clear idea of how much was involved.

It is interesting to note that the founder of that firm, Hank Greenberg, is now suing the federal government on the grounds that he and other shareholders were treated too rudely when the Bush administration had to step in to pay their debts to prevent a complete meltdown of the global economy. To their credit, the current managers of the company have dissociated themselves from this, leaving Greenberg alone to play the role of the arsonist suing the fire department for water damage.

One of the major advances in the financial reform bill that we adopted in 2010 was to reverse an earlier decision led by Republican Sen. Phil Gramm to prevent any federal agency from setting rules for these financial derivatives – the ones that Warren Buffett semi-jokingly called “weapons of mass financial destruction.”

The legislation requires that those trading in these entities use open exchanges in most cases, and where the particular transactions are too unusual, that those engaging in them be required to have sufficient funds to meet their obligations. There is also a requirement that in all cases the prices being charged for these transactions be made public, a rule that many in the financial institutions bitterly oppose because it allows competitors to underbid them.

Because financial derivatives have some of the characteristics of the commodity-based trades of years ago, but are also securities in other regards, the enforcement of the safeguards adopted to prevent another AIG debacle is done by two federal agencies: the Commodities Futures Trading Commission and the Securities Exchange Commission. The commissioners of the two institutions have done a good job of coordinating, and the result has been significant progress in making it much less likely that irresponsible derivative trading will contribute to another crisis.

Any effort by the Republicans to repeal the rules that we adopted regulating derivative trading would be clearly unpopular, and even if they were to pass such a proposal in both houses, President Obama could veto it. But there is a more insidious possibility.

Both the Securities Exchange Commission and the Commodities Futures Trading Commission are dependent on Congress for their annual budgets. In the area of bank regulation, the relevant agencies have their own funding sources, so that a Congress inclined to cripple regulation is unable to do so easily. But both the SEC and the CFTC have already suffered from the takeover of the House in 2011 by a Republican Party opposed to financial regulation. There has been criticism of both agencies for not moving more quickly in adopting rules that we called for in the bill, but most of that criticism ought to be directed at Congress, and specifically at those Republicans who have used their power in the budget process to withhold the funds that the two agencies need.

The largest grant of additional power in the financial reform bill was to these two agencies to regulate the previously unregulated area of financial derivatives. The amounts involved here are enormous – hundreds of trillions of dollars are at stake. But the two agencies have simply not been given the funds they need to hire both the sophisticated lawyers and economists and the up-to-date information technology needed to stay on top of this activity.

The Democratic Senate has been able since 2011 to keep the Republicans from cutting the funding too deeply. But with the Senate now in Republican hands, that protection is no longer there.

The danger that the economy faces is stark. The Republicans are not likely to make a frontal assault on derivative regulation. But there is a very real possibility that they will use their control of both Houses further to weaken the ability of these two agencies to defend us against the kind of harm we experienced in the years before the legislation was passed. The president can veto any direct assault. But there is nothing the president can do to force increased funding for these two protectors of the economy. Getting public opinion to focus on something as specific as the appropriations level for these two regulatory commissions will be difficult, but it may be necessary if we are to keep in place the safeguards we only recently acquired against the kind of financial irresponsibility that did us so much damage a few years ago.

Barney Frank is a retired congressman and the author of landmark legislation. He divides his time between Maine and Massachusetts.

Twitter: @BarneyFrank

— Special to the Telegram