Blanche Lincoln's Derivatives Bill: Amateur Hour (But Probably Fixable)

So it turns out that Blanche Lincoln's derivatives bill (pdf) is a bizarre mix of solid and utterly insane. The bill understandably punts on what is far and away the most important issue in derivatives reform: the scope of the clearing requirement, which is left to the discretion of the CFTC. That's to be expected, and probably the best way to go. The bill does set up a pretty good process for deciding which instruments will be required to clear, which will most commonly involve the CFTC reviewing an instrument that a clearinghouse decides to list and make available for clearing, and determining whether or not to make clearing mandatory for that instrument.



The insane parts, however, are breathtakingly irresponsible. The "no bailout" provision (Section 106) would cut off the top 100+ US commercial banks, plus all the major dealer banks, from the Fed's discount window. That's insanity. I trust I don't have to explain why even introducing a bill with this kind of nonsense in it is so dangerous. If you want to know why Sen. Lincoln's bill is spooking the markets, look no further. It's not because the bill is "strong" — and, by the way, it doesn't even have an exchange-trading requirement, so you can't blame that. It's because the bill would hang most of the banking system out to dry by cutting them off from a central bank backstop, and if enacted, would seriously risk a run on the capital markets. This kind of bullshit has to go — the entire section needs to be deleted, forthwith.



Another crazy provision is Section 120, which would impose a fiduciary duty on swap dealers when entering into a swap with any pension fund, endowment, or retirement fund, as well as any governmental entity (federal, state, or local). This represents a phenomenal misunderstanding of how duties at the various levels of the market operate. ERISA already imposes a fiduciary duty on pension fund managers, trustees, etc., who then, as highly-paid professionals with a fiduciary duty, are empowered to deal at arms-length with dealers. Whether broker-dealers should owe a fiduciary duty when giving advice is a legitimate question, but it's also a completely separate question that has no place in a derivatives bill. Moreover, Lincoln's bill goes way beyond the issue of broker-dealers giving advice, instead requiring dealers to act as fiduciaries (to fund managers who are already acting as fiduciaries) whenever they even enter into a swap with a pension fund, endowment, governmental entity, etc. Look, market-makers are intermediaries; they can't owe a fiduciary duty to both sides. If you want to protect pensioners, then enforce the already existing fiduciary duties pensioners are owed.



These aren't the only bad provisions in Blanche Lincoln's bill (there are a few more), but they're by far the two most dangerous and destructive provisions. If we could strip the crazy out of Lincoln's bill, then it would honestly be a solid foundation. But let's first focus on stripping the crazy out.