It makes a future market melt-down more likely.
Today the Senate takes up Senator Blanche Lincoln’s amendment to regulate over-the-counter derivatives. The Lincoln bill is very, very bad, but don’t take out word for it, ask the Federal Reserve. Fed Staffers released a four page, seven point critique saying the Lincoln bill would “impair financial stability and strong prudential regulation of derivatives; would have serious consequences for the competitiveness of US financial institutions; and would be highly disruptive and costly, both for banks and their customers.”
The first point of the Fed “staff” critique echoes a point made in a 1990 article by then-Princeton professor Ben Bernanke explaining that derivatives clearinghouses are an integral part of the larger banking and payment system. Bernanke explained how Fed actions in to assure emergency funding to derivative clearinghouses avoided a “market breakdown” in the course of the 1987 stock market crash.
In reaction to the 2008 crisis the Lincoln bill would wholly divorce derivatives trading from banking and prohibit Fed involvement with derivatives dealers and clearinghouses. Lincoln’s throw-the-baby-out-with-the-bathwater approach would make it more likely that the next stock market crash will produce a total melt-down.
As another informed observer puts it, the biggest “systemic risk” to the economy is Congress, not derivatives dealers.