Financial reforms being formulated in the United States should have some welcome benefits for New Zealand investors, financial planner Peter Smith says.
President Barack Obama's Administration is planning to reshape the opaque world of derivatives trading but that is only seen as a preview of sweeping reform proposals that may be announced this week.
Mr Smith, the principal of Peter Smith Financial Planning, said derivatives trading was just a form of gambling and had been one of the major causes of the global financial crisis.
When things were going well, banks made huge profits from derivative trading.
But once things went bad, banks were left trying to fund losses without any cash.
Banks would buy huge amounts of the derivatives, betting the market would go one way or the other.
They would take out insurance to cover the other side of the bet.
But they were doing it all on paper, rather than having the cash to cover losses.
The reforms being proposed would mean banks had to make sure they had the money to cover losses.
"Banks will be more cautious about this type of market."
The new rules aimed to prevent the kind of chaos that occurred last year after the collapse of big financial firms involved in derivatives, including Lehman Brothers and insurer AIG.
Trillions of dollars in derivatives were traded each day, including various kinds of futures and option contracts.
Among the most controversial were credit default swaps, which were a form of insurance against a default in some types of securities.
Mr Smith said the financial system was pushed to near collapse last year when AIG and Lehman Brothers were put on the hook for trillions of dollars of failed subprime, or high-risk, mortgage securities.
Recently, US Citibank declared a $US4 billion ($NZ6.8 billion) profit for the three months ended March.
Of the total profit, $US2 billion was made by Citibank betting on itself that it would make a good return.
The remaining $US2 billion was gained through accounting charges.
The traders were not accountable to anyone and it depended on the nerve of his superior how far a trader could push the boundaries, he said.
The White House and the US Treasury, responding to the global financial crisis, have firm ideas about tightening oversight of hedge funds, streamlining bank regulation and shaking up executive pay standards But Reuters reported that two key components of the administration's approach - policing "systematic risk" and winding down troubled financial firms - were dividing senior officials and lawmakers.
That was likely to cause delays in getting broad reforms enacted.
The regulatory reform drive comes as economies around the globe continue to reel from a credit market paralysis triggered by a sudden plunge in the value of exotic securities created during the US real estate boom.
The US House of Representatives financial services committee is expected to hold hearings next month with a view to passing legislation before an August recess.
One key measure will be to empower the Government to seize and resolve the problems of troubled non-bank financial firms so big that their collapse could threaten the overall economy.
The Federal Deposit Insurance Corporation can do this now only for banks.
