Streetwise Professor

I was quoted in today’s WSJ:

Companies could try to skirt the regulations by creating new contracts that are similar but not identical to clearable trades.

“People will see where the lines are…[and] devise products that fall outside the scope of this particular regulation and that particular regulation,” said Craig Pirrong, a finance professor at the University of Houston.

The Treasury Department says that clearinghouses need to ensure that “customized OTC derivatives are not used solely as a means to avoid” clearing.

Regarding the sentence following my quote.  As I noted in my post on the proposed Treasury regulations, the clearinghouses are not in a good position to monitor the use of non-cleared products, due to their lack of information, and perhaps more importantly, their conflict of interest in seeing more business come their way.  Although the WSJ article accurately characterizes the Treasury’s position, so much the worse for Treasury.  It suggests a serious failure to think things through.

If they decide to prevent the use of customization to circumvent the clearing requirement, as it almost certainly must if the clearing mandate is to survive, Treasury and Congress will require a regulator to enforce the circumvention ban.  This would require an incredibly intrusive regulator, evaluating the design of every contract, and the intent behind it.  I can state almost categorically that no regulator has or will have the information, expertise, or ESP required to do this.  Moreover, this will just throw us back into the days of pre-CFMA requirement that all “futures” be traded on exchanges.  Not a good thing.  This created regulatory uncertainty, legal ambiguity, and served to protect the interests of exchanges.  One can only imagine the Talmudic inquiries that would be involved in determining whether a particular derivative is, or should be cleared, or was designed to escape a clearing mandate.

Regulators–or clearinghouses serving as their agents–should not be in the position of intervening so intrusively in the contracting decisions of derivatives markets participants.  Such intrusion will raise transactions costs, and interfere with the efficient allocation of risk in the marketplace.  What’s more, there is no reason to believe that this interference will reduce systemic risk.  Indeed, it could well increase systemic risk.