Streetwise Professor

There have been several articles over the last couple of days regarding the implications of the CFTC’s and SEC’s inability to write the rules necessary to implement Dodd-Frank.  In a nutshell, Dodd-Frank repeals the Commodity Futures Modernization Act, which gave legal certainty to swaps.  When Dodd-Frank goes into effect, if the rules are not in place–a near inevitability–losing participants in derivatives deals–and remember boys and girls, there will be one in every deal!–may attempt to escape their losing OTC derivatives trades by claiming that the agreements are illegal off-exchange futures.

The CFTC’s Gary Gensler says “trust me on this.”  I’m with the WSJ on this one:

Commodity Futures Trading Commission Chairman Gary Gensler says his agency and the Securities and Exchange Commission are working on clarifications to guide derivatives markets for the period between July 16 and whenever regulators decide on new rules. He promises to post something on the CFTC website soon.

But not everyone is convinced that Gary’s web posting is going to defuse the bureaucratic bomb that Chris and Barney have programmed to detonate next month. Mr. Gensler can’t prevent private lawsuits if the law becomes murky. It doesn’t take too much imagination to see trial lawyers trolling the ranks of underachieving municipal finance officials who might want a do-over after some bad derivatives bets. We could immediately be talking about real money.

In other words, a CFTC web posting or Gary Gensler writing on his Facebook wall (and no, he hasn’t friended me!) or Tweeting that it’s all cool (and no, he doesn’t follow me nor I him!) of whatever won’t deter firms with big losses from taking a punt on a lawsuit.  Even if, in the end such lawsuits go nowhere, (a) uncertainty about this will chill some business, and (b) legal costs will be appreciable.

In other words, this is just another big screw up.  And it’s merely a procedural screw up–a problem that Congress in its infinite wisdom (for those who come for the sarcasm–there you go!) could have anticipated and addressed.  We haven’t even gotten to the potential substantive screw ups.  Screw ups that the financial world is now viewing with growing alarm.  People are starting to recognize that the unintended substantive consequences of Dodd-Frank–e.g., making CCPs too big to fail entities, the liquidity impacts of clearing mandates, to name just two of the biggies–could be the source of the next crisis.

So, as we venture into this brave new world, folks, don’t forget who brought the broomsticks to life but couldn’t control them: