Blanche Lincoln has expressed uncertainty as to whether the no Federal assistance clause in her bill will survive to become law. (Here’s hoping, though the Republicans caved–I’m shocked!, shocked!–at holding up the Dodd bill which Steve Bainbridge rightly calls “evil.”) Perhaps one reason for her uncertainty is that some anonymous Fed staffers threw some “comments” on the bill over the transom. (Which raises the questions: why do these staffers feel the need to be anonymous? Why hasn’t the Board, or Bernanke, taken a stand on this?) (We know with probability 1 that SWP’s cogent critiques had nothing to do with Lincoln’s uncertainty!)
Echoing my original take, the comments trashed the dreaded section 106:
1. Section 106 should be deleted.
a. Lending to financial market utilities. Section 106 would prohibit any federal assistance to swap dealers, major swap participants, swap exchanges, clearinghouses and central counterparties. This would appear to override the provision of Title VIII that would allow the Federal Reserve to provide emergency collateralized loans to systemically important financial market utilities, such as clearinghouses and central counterparties, to maintain financial stability and prevent serious adverse effects on the U.S. economy.
i. As systemically important post-trade “choke points” in the financial system, it is imperative that these utilities be able to settle each day as expected to avoid systemic problems and allow for a wide range of financial markets and institutions to operate. The failure of a systemically important utility to settle for its markets would not only call into question the soundness of the utility as a critical market infrastructure but could also create systemic liquidity disruptions for one or more markets and potentially other financial market utilities. The increased importance that Title VIII places on central counterparties and central clearinghouses to reduce risk in the financial system necessitates ensuring that short-term secured credit is available to these utilities in times of stress.
b. “Push-out” of bank swap activities. Section 106 would in effect prohibit banks from engaging in derivative transactions as an intermediary for customers or to hedge the bank’s own exposures.
i. Title VI, which includes the so-called Volcker rule provisions, better addresses the problem of risks from derivatives activities by prohibiting any bank, as well as any company that owns a bank, from taking speculative, proprietary derivative positions that are unrelated to customer needs.
I would disagree only to the extent that I think the Volcker rule is inane too.
The interesting question is where this insanity came from. In the months leading up to the announcement of the Lincoln bill, mandatory clearing was always on the table; mandatory exchange or exchange-like trading was constantly discussed; but the no Federal assistance provision was never broached. How can it happen, so late in the day, that such a momentous provision, fraught with the potential for massive consequences (that are almost impossible to forecast with any precision), can appear in a piece of legislation like a bolt from the blue? The cavalier attitude on display here is frightening.
I have another question, related to the consequences. During the Crash of ’87 clearinghouses didn’t have direct access to Fed assistance. Nor do they now, for the most part. But the Fed clearly provided liquidity support in 1987 that although not directed to CCPs or FCMs directly, indirectly supported them. The Fed flooded the system with liquidity, and “persuaded” (the quotes are in Bernanke’s article about the event) banks to take the liquidity and lend it to securities firms and FCMs to make sure that they would be able to meet margin calls. The Fed also permitted Continental Bank to inject capital into First Options, which probably saved OCC; Continental, I believe, received Fed liquidity.
Would it be legal for the Fed to do provide the same indirect support under Section 106? It seems ambiguous. The Fed’s actions in 1987 were clearly undertaken with the intent of saving clearinghouses, and had this effect. Do we really want lawyers (or judges) trying to figure out whether such indirect assistance is legal when the financial system is on the brink? Or will the fear of such a constraint lead to the kind of backroom dealing and cover-ups that occurred during and after the AIG bailout? (And which, by the way, may get Timmy! in the legal crosshairs of the TARP Inspector General.)
Has anybody in the Senate even thought about this?
You know, when you play chess, or plan military strategies, you have to think several steps ahead. You have to play “what if?” I believe, with almost metaphysical certainty, that nobody who will be voting on this has done so. More often, they are looking back, and learning false lessons about the past, or ignoring potentially informative experiences, or just engaging in pointless political posing and posturing. Which bodes very ill for the next future, and the next crisis–when, and not if, it occurs.
Which is just one reason why Congress is the biggest systemic risk.