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Derivative Handcuffs, More Red Tape in Finance Bill

by Dan Barrett / /

The Restoring American Financial Stability Act tries to reduce the likelihood and severity of financial crises. It joins the varied government programs and agencies which have succeeded in the past: The Social Security Administration, guaranteeing years of retirement longevity with a bright future ahead, The Medicare Program locking seniors into rock-solid boilerplate health plans (so good people need not ask the government to raise taxes for its operation), The Freddie Mac and Fannie Mae loan corporations, ensuring whenever there's a market downturn everyone suffers its educational effects. This short list can't ignore the benign Federal Reserve, the incredibly friendly Internal Revenue Service, or the accurate and timely Securities and Exchange Commission.

Kidding aside, the Senate entered its fourth round of cloture votes to end debate on S3217, the federal government's response to 2008's credit crisis. Introduced by Senator Dodd, the bill aims to prevent financial panics through regulation.

Bill provisions include:

  • Creating a program correcting insolvent financial institutions: $50 billion worth in fees would fund liquidations of complex banking and investment corporations. The Congressional Budget Office cites, "although the probability that the federal government would have to liquidate a financial institution in any year is small, the potential costs of such a liquidation could be large" but also the $50 billion "reflects CBO's best judgment on the basis of historical experience, the cost of the program would depend on future economic and financial events that are inherently unpredictable." Translation: plan on the government coming to the rescue in "too big to fail" fashion for years to come.
  • SEC Regulation Free-for-all: As the stock market regulator is given authority to collect fees from its purview, 800 SEC staff would be added to oversee the registering of certain derivatives advisors and increased oversight of credit rating agencies.
  • Another Protection Agency: The Bureau of Consumer Financial Protection will operate out of the opaquely transparent (i.e. elected kings) Federal Reserve, regulating credit unions with more than $10 billion in assets and "supervising" large lenders and brokers. The agency is estimated to cost $4.5 billion over 10 years.
  • Stability Mandates: The financial Stability Oversight Council would arbitrarily identify risks to US financial stability at an annual cost of $75 billion.
  • Bureaucratic Goggles for Derivatives: Perhaps the most serious part of this regu-slation is the further regulations on derivatives. Derivates are "a financial contract with a value linked to the expected future price movements of the asset it is linked to", a better explanation can be found here. Companies investing in this market will be forced to set aside funds to cushion derivative downfalls, which will cut into profits and reinvestments. Some derivative transactions would also have to be registered on exchanges, bringing more under the authority to the Commodity Futures Trading Commission. Derivatives are used to hedge risks in light of unforeseen future conditions but these rules will hinder businesses from effectively managing their own futures, as they will spend more time peeling red tape from their work.

For a more 30,000 foot view of both sides' plans on financial reform, check out my old post on a comparative Reason Foundation Report. The Heritage Foundation has also weighed in on the "too big to fail" controversy.

Overall, Americans need to be better informed about the financial engine. Politicians cite 2/3 of Americans supporting this bill but I suspect few know, or have heard of, a derivative. While reform can take place, government remains the source of our financial problems as a nation. As spending cuts further into private investment, perhaps government should regulate itself for a change and leave the formerly free-market to the entrepreneurs.