One way to think of the credit crisis of 2007 and 2008 is as a problem with the plumbing. Malodorous mortgages sloshed through the financial system, poisoning the water for everyone. Knitted together by a network of complicated pipework, banks found that nasty things backing up inside one institution could quickly explode, showering the rest of them in – well, let's just say the general public is still holding its nose when it comes to Wall Street.
Five years after the financial system sprang its first leaks, the plumbing is being reorganised. Government regulators around the world have already done a lot to try to make banks and other institutions less likely to fail, by demanding they reserve more capital against shocks or hive off risky businesses. The other half of the work is about making sure that, if one institution fails, it isn't so intricately connected to the rest that they get poisoned too.
The man in charge of rerouting the pipework, in the US at least, is Gary Gensler, chairman of the Commodities Futures Trading Commission (CFTC). When he addressed the annual conference of the International Swaps and Derivatives Association (ISDA) this week, his audience was the very people whose pipes he is twisting. And yes, that is as painful as it sounds.
"This is the first ISDA conference to be addressed by the head of the CFTC," he said. "I suspect it won't be the last." It was said with just a hint of menace.
Swaps are a kind of private derivative used to hedge the risk of a price going up or an interest rate changing or a currency fluctuating or a creditor failing to pay, or to speculate on any and all of the above. They are traded "over-the-counter" (OTC) directly between banks and between banks and their customers. And before the wake-up call of 2008, they were exempt from regulation – which, given the total value of over-the-counter derivatives has grown to $700trn (£432.76trn), turned out to be rather a large oversight.
Instead of allowing these trades to flow directly through the pipework between banks, Mr Gensler – following a philosophy set out by the G20 heads of government and a legal blueprint in the Dodd-Frank Wall Street reform laws in the US – is forcing the majority to go through central clearing houses. These are middlemen with their own capital cushion, so if one party to a trade goes under, the other still gets paid.
It was the example of AIG, Mr Gensler explained on the sidelines of the meeting, that persuaded lawmakers to act. When the insurance giant teetered on the edge of bankruptcy in September 2008, days after Lehman Brothers' collapse, the US Treasury felt it had no choice but to intervene. AIG had $62bn of swaps on its books, and there was panic at the prospect of its trading partners – Goldman Sachs and Deutsche Bank among them – not getting paid, and of them consequently not being able to pay their own trading partners. The US taxpayers' bailout money left AIG "in seconds" and flowed through to secure those counterparties, Mr Gensler said. It was a debacle that must never be repeated.
"No one would say the financial system got an A-plus in 2008," the CFTC chairman said. "I would say it got an F. I would say the regulatory system, the Washington side, got an F, too."
So here is ISDA, gathered in Chicago, arguing as best it can to preserve as much of the lucrative status quo as it can, against a regulator determined to exercise control over a huge, new domain.
With 1,000 people in attendance, the first striking thing is how many English accents rise above the hubbub. Striking, but not a surprise, since 47 per cent of OTC derivative trading occurs in London. ISDA's chairman, Stephen O'Connor, a managing director at Morgan Stanley in New York, is a Brit. The City of London's boom, pre-crisis, was built in no small measure on the profits of the swaps market; the extent of its recovery will be more or less proscribed by what is decided by Mr Gensler and the European Union officials who are drafting inter-locking regulations.
The EU's European Market Infrastructure Regulation may not be ready by the end of this year, as G20 leaders demanded, but it won't be far off, and Mr Gensler promised there would be co-operation rather than competition between international regulators this time, to avoid confusion for the market and to stop banks playing one jurisdiction off against another.
The industry is not fighting the principle that it must now be regulated, but it is engaged in a host of skirmishes over the detail of the new rules and maintains a harrumphing tone when it comes to discussion of the new requirements for clearing trades in particular. Participants expressed scepticism that clearing houses will be any better at managing risk than the swaps dealers themselves; several suggested the clearing houses will become "too big to fail" and might even trigger the next crisis.
"It is not risk-free," Mr Gensler conceded to reporters, "but it is better than leaving these risks with the banks."
And he added that clearing houses will be made safer by another set of rules he is putting in place, namely rules to make trading of OTC derivatives more transparent. This is the bit that really makes ISDA's swaps dealer members wince. The CFTC is outlawing trading over the telephone in favour of electronic platforms where prices can be displayed in real time, and has even proposed rules that force swaps users to shop around for quotes.
Mr Gensler practically grinned at the prospect that this will hit dealers' profits – for the benefit of swaps users.
"It is what happens if your bring people into the public square. If all the apple merchants are in the square, the apples are going to be priced more tightly," he said. "I accept that this is something dealers are not going to love."
As Mr Gensler was speaking in Chicago, the chief executives of the nation's largest investment banks were meeting with other regulators at the New York Federal Reserve to complain about, among other things, the extra rules that are being put on them because their size has been identified as a danger to financial stability. In particular, they are upset at a requirement that limits them to doing no more than 10 per cent of their trading with any single counterparty, for fear of the consequences if that counterparty does an AIG.
For now, though, regulators – whether they be in Chicago or New York, Europe or beyond – are keeping more or less resolute. The world's financial institutions must be disentangled for their own good and for ours, they say. The plumbing must be fixed.