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Derivatives Bill: It’s Less Bad, but Still Bad

Posted By Dave Mason On October 26, 2009 @ 11:01 am In Economics | Comments Disabled

Two House committees this week approved derivatives legislation [1] that composes a significant part of the Obama Administration’s Financial Services reform plan. Remarkably, for a plan crafted significantly by uber-liberal Barney Frank (Chairman of the House Financial Services Committee), the bill is notably less bad than the Administration’s original proposal, but still is flawed. The House Agriculture Committee also added amendments to the bill.

Heritage noted before [2] that derivatives market participants are rapidly changing their business practices and structures in a voluntary, cooperative effort, albeit under government sponsorship [3]. The biggest danger in cranking up regulation is that well-intentioned directives from bureaucrats will disrupt productive markets self-corrective processes and result in unintended consequences. This danger is greatly reduced when market participants have responsibility for designing fixes to the problems government identifies.

The Administration’s proposal would have allowed regulatory agencies to write the procedures under which derivatives exchanges and clearinghouses operated, which would have made running those organizations difficult and costly. One of the most important changes made by the House Financial Services Committee was to preserve a cooperative structure in which derivatives market participants have a voice in regulatory structures and methods and generally to allow market participants more flexibility in meeting regulatory mandates.

The Committees also made numerous changes to mitigate the one-size-fits-all nature of the Administration plan. The ostensible problem requiring regulation of derivatives was the “systemic risk” presented by billion-dollar volumes of derivatives, as illustrated by the failures of Lehman Brothers and AIG. Assuming those arguments are valid, it might at most make sense to regulate large entities trading huge volumes of derivatives, but not regulating every transaction and every firm with any interest in derivatives, as the Administration insisted. Amendments in both Committees exempted certain types and sizes of transactions and users, focusing regulatory fire on the supposedly “systemic” problem.

Unfortunately, “less bad” isn’t good. Giving regulators a relatively vague, if now less broad, charge to interfere in markets is still likely to result in increased costs, reduced competition, and barriers to innovation. It is, however, encouraging seeing that even with an ideologically-similar President and Congress, the founders’ genius in separating powers still generates relative improvements in legislation.


Article printed from The Foundry: Conservative Policy News from The Heritage Foundation: http://blog.heritage.org

URL to article: http://blog.heritage.org/2009/10/26/derivatives-bill-it%e2%80%99s-less-bad-but-still-bad/

URLs in this post:

[1] derivatives legislation: http://www.house.gov/apps/list/speech/financialsvcs_dem/otc_discussion_draft.pdf

[2] noted before: http://www.heritage.org/Research/Regulation/bg2262.cfm

[3] under government sponsorship: http://www.newyorkfed.org/newsevents/otc_derivative.html

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