The Treasury Department plans to exempt foreign exchange derivatives from new Wall Street reform regulations, a Treasury official said Friday, dismissing concerns that the market prompted $5.4 trillion of emergency support from the Federal Reserve in late 2008.

Assistant Secretary for Financial Markets Mary Miller told reporters on Friday that the foreign exchange market already functions effectively and would not benefit from new rules. Subjecting the market to new rules, she claimed, would introduce a new and unnecessary “process” into “a very well-functioning market.”

But a 2009 study by Naohiko Baba and Frank Packer of the Bank for International Settlements concluded that there were major "dislocations” in the foreign exchange market in the aftermath of the Lehman Brothers bankruptcy -- problems that were only resolved after the Fed pumped money into foreign central banks in order to ensure that global banks had access to dollars.

“After the bankruptcy of Lehman Brothers, the turmoil in many markets became much more pronounced,” wrote Baba and Packer. “In FX and money markets, what had principally been a dollar liquidity problem for European financial institutions deepened into a phenomenon of global dollar shortage.”

Last year’s Wall Street reform bill required derivatives to be centrally cleared, a safety measure which helps ensure that the overall market does not falter if a bank or hedge fund cannot make good on its trade. But the law gave the Treasury Secretary Timothy Geithner the authority to exempt foreign exchange derivatives if they did not pose a threat to the financial system. The market Treasury hope to shield from regulation totals roughly $30 trillion, according to the Treasury, and is the dominant means for trading currency in global financial markets. Treasury is not exempting a broader class of more complex currency derivatives from the new rules-- only the market for FX "swaps and forwards" would be effected.

Foreign exchange derivatives, also known as the FX or ForEx market, are among the most profitable trading operations on Wall Street. “If the too-big-to-fail banks gave out academy awards, Geithner would be best supporting regulator year in and year out,” said Michael Greenberger, a former top official at the Commodity Futures Trading Commission, noting that Goldman Sachs scored $2.2 billion in trading revenue on FX in a single quarter last year.

Financial reform advocates argue that the FX derivatives Treasury wants to shield from regulation would have cratered if the Fed had not established emergency lending facilities with central banks in other countries. As foreign banks clamored for dollars in the aftermath of the Lehman Brothers bankruptcy, the Fed pumped $5.4 trillion into those programs, based on calculations by the financial reform group Better Markets, using data from the December Fed audit.

“Only massive, emergency and unlimited Fed intervention in the foreign exchange markets prevented a collapse,” wrote Dennis Kelleher, CEO of the financial reform group Better Markets, in a February letter to Miller.

“[Treasury’s] principal justification is that this market never had problems,” Greenberger said. “And yet some very smart people have reviewed the data and concluded that it would have collapsed without a Fed rescue.”

Miller insisted on Friday that the central bank’s actions in 2008 were not an emergency response to save a faltering FX market. “The Fed actually did not intervene in this market,” Assistant Secretary for Financial Markets Mary Miller told reporters on Friday. “I think some people confuse the extension of the Federal Reserve’s swap lines to central banks globally to provide dollar liquidity which was in high demand in the financial crisis, with the ForEx swaps and forwards market.”

Kelleher previously addressed this argument in a March 23 letter to Miller.

“While it is true that the Fed only lent via swap lines to foreign central banks and did not lend directly to the ForEx market, it nonetheless did so in part because the FX market was not providing sufficient dollars to foreign financial institutions,” Kelleher wrote.

On Friday, Miller also argued that because foreign exchange derivatives are typically very short-term contracts, the risk of problems arising are very low. But problems in another short-term market, the “repo” market, sparked the Lehman Brothers bankruptcy.

“Well, the repo market is an overnight market and it collapsed,” said Michael Greenberger. “The whole purpose of the clearing requirement is to have a guarantor there when your counterparty collapses.”

During last year's financial reform bill debate. CFTC Chairman Gary Gensler warned that exempting FX derivatives would allow firms to disguise other trades as FX, enabling large portions of the broader $600 trillion derivatives market to evade regulation.

The Treasury will accept public comments on its plan to exempt FX derivatives from new regulations, and make a final determination afterwards.