Senator Chris Dodd’s monstrous 1336-page financial reform draft includes a whopping 217 pages devoted to “improving” over-the-counter derivatives markets. Dodd the derivatives section may be replaced by a yet-to-be-released bipartisan compromise from Senators Jack Reed and Judd Gregg. But the Dodd draft suggests that legislators are focused on bureaucratic imperatives rather than improving markets.
The biggest blind spot in Dodd’s draft is the assumption that only command and control regulation can improve markets. In fact, beginning even before the financial crisis, an international cooperative effort of derivatives market participants led by the New York Federal Reserve has led to significant improvements in the market.
Over the past 18 months, while Washington dithered, derivatives market participants standardized derivatives products, implemented central clearing, began informational reporting to the public and regulators, and are exploring exchange trading. The Dodd draft is written as if none of this ever happened, perhaps for no better reason than that the steps were not mandated from Washington. In fact, Dodd calls on the industry to achieve just these steps six months or a year after his bill is passed (assuming that ever happens).
Having Washington pile on now with more regulations will only disrupt what the markets have already achieved, and freeze progress in late 1998 when the concepts in the Dodd draft were first floated.
Even assuming derivatives require more regulation, Dodd’s second mistake is fixating on who gets the job rather than how it is done. Differing types of derivatives have attributes akin to securities, futures, insurance, and banking products. Derivatives confound jealously-guarded jurisdictional boundaries in existing bureaucracies and, even more disconcertingly for legislators, in Congress.
Dodd proposes a classic Washington compromise: decide not to decide. The Dodd draft solves the jurisdictional conundrum by giving joint jurisdiction over derivatives to two Washington-based agencies: the Securities and Exchange Commission and the Commodity Futures Trading Commission. Disputes between the agencies are to be resolved by a new regulatory council composed of representatives of those two and yet other financial regulatory bodies.
In other words, if two commissions with ten commissioners can’t solve the problem, Congress will call in … even more commissions and agencies.
What’s puzzling is why Dodd ignores the one agency that (a) has experience in regulating derivatives trading and (b) has actually fostered recent major derivatives market improvements: the Federal Reserve Bank of New York.
It’s not as if Dodd is unaware of the New York Fed: his draft proposes to make the Chair of the Bank a Presidential appointee subject to Senate confirmation.
There’s no reason for Congress to add another layer of regulation on to this market. Cranking up regulation could in fact make things worse by disrupting the positive changes already taking place. Bureaucrats will disrupt productive markets self-corrective processes and result in unintended consequences. But if Congress does intervene, any steps should reflect the current state of the derivatives markets, not where they stood two years ago. And Congress should give any regulatory authority to an agency with a proven track record at improving markets, rather than creating a gridlock-prone dual-headed scheme.
