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Salmon on Lincoln

April 13, 2010 - by Donny Shaw

Yesterday, Sen. Blanche Lincoln [D, AR] surprised just about everyone (including yours truly) by announcing that her derivatives bill was going to be stronger than anything we’ve seen from Dodd, the House of Representatives, or the White House. Felix Salmon has a helpful post clearing up some confusion between exchange trading and clearing requirements, and outlining what we can expect in her bill, which will officially drop tomorrow:

The easy way to think about this is that if an instrument is exchange-traded, then it will always be cleared by the exchange as well. It’s possible to have central clearing of derivatives transactions without having them exchange-traded, but you can’t have exchange trading without central clearing.

Lincoln wants to mandate exchange trading for most derivatives, although it looks as though she might give the CFTC final say on that front. If a company gets an exemption from having to clear its trades centrally, then, it will also have to get an exemption from the exchange-trading rules. And so Lincoln wants to make those exemptions very rare indeed.

Lincoln also wants to regulate foreign currency swaps, in a move which goes further than even Treasury wants to go. And more generally, in a Volcker-like move, she wants the big investment banks’ swap desks to be spun out of their bank parents, to prevent contagion and to help make them small enough to fail.

The remaining question, I suppose, would be whether or not swaps that get an exemption from clearing will be required to post margin to offset risk. If not, and if the clearing exemption ends up morphing into a giant loophole, there’s the potential for the A.I.G. problem to happen again where a failing company is too systemically important to be allowed to fail because it would mean that all of their swap transactions would not be paid out. This is the kind of thing we’ll be able to see tomorrow when we get the legislative text of the bill.

The question may be moot, anyways. Salmon thinks the Lincoln bill is just way to strong to get through the bank-friendly Congress:

But it’s also pretty clear that none of this is going to happen. Never mind Republican support: this is going to have a hard time even getting Democratic support. It’s all a good idea, but it’s far too radical: while it might have had more of a chance if it had been introduced during the height of the crisis, at this point the banks have got their mojo working again and will quite easily be able to ensure that the beating heart of Lincoln’s proposals is surgically excised before it even gets anywhere near a vote.

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