Rep. Jim Leach, R-Iowa, has proposed a bill on derivatives that Beese said takes a ‘modest approach.’ But he warned that fears in Congress of overlooking the next savings and loan crisis could lead to an overzealous response by legislators.

Perceived dangers? Come on, Dow Jones, can’t we drop the qualifier, or at least clearly attribute it to Beese? The GAO clearly had an uphill battle ahead of it, and the report hadn’t even come out yet.

“Fear” was the order of the day, as the May 18 release date approached. May 4, the AP informed us:

A much-awaited study on the controversial derivatives business proposes significantly tighter regulation of the booming market, with an eye to minimizing the potential of a financial catastrophe, sources said Wednesday.

The report by the General Accounting Office, in the works for several months, has been much feared by Wall Street banks and securities firms.

They have privately voiced concerns that the study by the GAO, the investigative arm of Congress, would lead to excessive regulation of derivatives. That would, in turn, drive the lucrative business offshore into the arms of European and other foreign bankers.

May 10, Dow Jones made clear where some ex-regulators stood on the matter:

The battle lines are forming on whether Congress should legislate new rules and safeguards for derivative financial products, and two former regulators came down firmly on the side of those who want Congress to do nothing.

‘The sky is not falling,’ declared ex-Securities and Exchange Commission Chairman Richard Breeden, now chairman of the Financial Services Group of Coopers & Lybrand, at a House subcommittee hearing attended by a batch of lobbyists anxious to ward off derivatives legislation.

Former New York Federal Reserve Bank President E. Gerald Corrigan, now with Goldman, Sachs & Co.—who not long ago warned that derivatives might be introducing new elements of risk into the financial system—joined Breeden in urging Congress to forego trying to enact reforms for derivatives.

And then the May 14 issue of The Economist really went to bat for the anti-regulatory camp, with an almost 3,000-word piece on derivatives. Here is the synopsis:

Regulators worry that huge growth in options, futures, swaps and other derivatives threatens the stability of the whole financial system. To the extent it does, regulation is warranted. But that extent is small, and otherwise the markets will judge the risks better than regulators can.

The Economist took on legislators whose concern over derivatives had led to both the GAO study and a variety of legislative proposals to curb derivatives:

One reason for America’s wariness is that legislators there want to improve on a hitherto poor record of anticipating financial disasters. They failed to foresee either the thrift debacle or the collapse of the junk bond market in the 1980s. Derivatives now offer an attractive target: they are a little-understood market with very big numbers attached. But that does not necessarily make them a threat to the system. On the contrary, used properly, derivatives can spread and even reduce risk in absolute terms rather than increase it.

The piece goes on to knowingly tell us:

In fact, because derivatives contracts are a way of spreading risk, they should improve rather than damage the aggregate position of companies linked by them.

Nice theory. Too bad it turned out to be utterly wrong.

But as much resistance as there was before the report came out, it paled in comparison to the response to its publication. Then the industry, with some help from some influential federal regulators, really tore it up.

Dow Jones, May 18:

Fast on the heels of a General Accounting Office recommendation that Congress enact legislation to lessen perceived financial system risks arising from derivatives, six leading financial trade groups, including the Public Securities Association and Securities Industry Association, stated their opposition to any derivatives legislation.

Other trade groups joining the statement of opposition to legislation on derivatives were the American Bankers Association, Futures Industry Association, the Bankers Roundtable, and the International Swaps & Derivatives Association.

Elinore Longobardi is a Fellow and staff writer of The Audit, the business-press section of Columbia Journalism Review.