When Congress, as part of a government-funding deal during the lame-duck session in 2014, repealed a key provision of the 2010 Dodd-Frank Wall Street reform bill, it removed an important protection against the consolidation of power in too-big-to-fail financial entities. What, precisely, did it do? Professor Mark Roe of Harvard Law (who, incidentally, taught my Corporations class when I was a student there) offers this fairly accessible explanation:
The Dodd-Frank rule that Congress just repealed, known as the “swaps push-out rule,” would have required that most derivatives-trading activities occur outside of government-insured banks. If a bank fails, the government stands behind most deposits. Though it does not formally guarantee anything else, it usually finds it easiest and quickest to bail out the entire bank – including its derivatives facility. If, however, derivatives are no longer embedded in the guaranteed bank, the government could more easily bail out a bank, while leaving the derivatives subsidiary to fend for itself.
This sub rosa government indemnification of major banks’ derivatives portfolios undermines financial stability. If a major bank defaults on its derivative trades, the banks with which it has traded could also fail. If several large, interconnected derivatives-trading banks collapse simultaneously, the financial system could be paralyzed, damaging the real economy – again.
His whole op-ed is worth a read.
