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.


Anonymous said...

People believe that Goldman Sachs was allowed to become a BHC solely so they could borrow from the discount window for 0% and buy treasuries paying around 4%. Matty Tabby apparently cursed this was true, so they believe it. They believe everything that moron says.

I rather doubt Goldman Sachs did much borrowing at the discount window. The mob thinks they made tens of billions of dollars doing it.

So they want it stopped.

sav said...

JCH, cannot Goldman just release the information about the discount window? If they have't borrowed it'll clear the air.

I remember reading a times article saying goldman only used the discount window once. and that was a test transaction. I'll try look it up.

sav said...

"Despite taking on holding company status during the financial crisis, Goldman has used the Fed’s discount window just once, in a $10 million test run, and argues that it does not rely on cheap money from the Fed."

found it.

Anonymous said...

Great find, sav. I did an analysis of the Fed's monthly reports, and from that you can basically conclude that GS's discount window borrowing was very small.

But a mere ten million, if true, is genuinely hilarious.

Many progressives think Goldman has borrowed 100s of billions from the discount window. It is a pillar of their misguided outrage.

Anonymous said...

Section 106, as Lincoln has described it, is meant to force the banks to spin off their derivatives desks, not to cut them off from federal liquidity.

Anonymous said...

as in, i'm not sure about your claims about ERISA and fiduciary duty. but the Ag Committee staffers spent a lot of time on this particular bill, and if you are going to mischaracterize a key section of their bill, which has been frequently discussed and described in all sorts of media as a means to force federally backstopped banks to spin off their OTC derivatives desks, as something that just cuts off fed funds from the top 100 banks, then I'm not particularly strongly inclined to believe your claims that the fiduciary duty they impose is wrongheaded.

Economics of Contempt said...


First of all, the title of Section 106 is "Prohibition against Federal Government Bailouts of Swaps Entities," and it was described in the press as the "no bailout" provision, so I in no way mischaracterized that provision.

Second of all, even if Section 106 were intended to force banks to spin off their swaps desks, that wouldn't make it any less crazy. Banks use swaps. Extensively. They are a crucial and necessary tool for managing all kinds of risks, particularly interest rate risk. The idea that banks would be made safer if they weren't allowed to be Major Swap Participants is beyond laughable.

For that reason, regardless of what Sen. Lincoln may or may not have intended Section 106 to do, it would undeniably have the effect of cutting off a huge portion of the banking system from the Fed window. Banks wouldn't stop using swaps (they're way too useful), so the effect would be to cut them off from federal liquidity. (And this isn't a "pro-Wall Street" view; the idea that things like interest-rate swaps are a legitimate risk management tool for banks has been completely uncontroversial for over 25 years.)

Finally, what on earth is the Ag Committee doing dictating central bank policy, and telling banks what they can and can't do? That's the Banking Committee's domain (regardless of how long the Ag Committee staffers worked on the bill).

No, I'm standing by my post: Lincoln's bill includes provisions that are breathtakingly irresponsible, and need to go, immediately.

Anonymous said...

Your comment is just as misleading as your original post, when it comes to Section 106. Go back and read the language more closely.

You are missing the clear distinction between derivatives DEALING, which is what the Lincoln bill targets, and the USE of derivatives.

Section 106, as you note, targets SWAPS ENTITIES. This is clearly defined as entities that are swaps dealers (or "major swap participants", which if you look into the legislative language, is a term of art describing an entity that is effectively a dealer/market maker). It is not targeted at end users, whether banks or non-banks.

As such, your entire analysis of this provision is wrong. It would do no such thing as cut off liquidity from derivatives trading, so long as that trading was of the end use variety. If Goldman wants to buy or sell a bunch of interest rate swaps, it can do so (although they would have to be exchange traded), it just can't be a DEALER in them and still receive any liquidity or other funding from the federal government.

The Lincoln bill would NOT, as you claim, effectively cut off banks from federal liquidity. It WOULD effectively force financial institutions to spin off their derivatives dealing desks (which would really only impact the top 5 Wall Street firms, who account for 97% of derivatives activity, according to CFTC Chair Gensler). That is a HUGE distinction, a misreading of which is the entire basis of your argument.

I will chalk this error up to laziness or maybe just a lack of time to look into it. But I think you owe your readers a correction, because your claims about this particular provision are wrong as they currently stand.

Economics of Contempt said...


No, you're completely wrong. The idea that the definition of "Major Swap Participants" only includes swap dealers is absurd on its face. Swap dealers and MSPs are two separate categories of swap participants. In fact, this is from the definition of MSP:

"The term ‘major swap participant’ means any person who is not a swap dealer, and..."

Moreover, the bill's definition of a "swap dealer" is so cartoonishly broad that it's being ridiculed by lawyers in the field. (Anyone who "regularly engages in the purchase and sale of swaps in the ordinary course of business"? Are you kidding? Please tell me that's a joke.)

Finally, if you think there are only 5 swap dealers in the US, then you've been badly misinformed. The top 50+ US commercial banks are all dealers in one category of swaps or another. The fact that most of them hold only a small percentage of the gross notional swaps outstanding is irrelevant to whether they would be considered "swap dealers" under the definition in Lincoln's bill (which says nothing about market share).

No, I fully understand the implications of Section 106 (I've been doing this for a very long time), and have not misrepresented anything. It's Blance Lincoln and the Ag Committee who don't understand Section 106. Which is why it needs to be deleted, without delay.

Anonymous said...

Dude, again with the misleading comment. Yes, "major swap participant" is a "non-dealer", which is why I mentioned it as separate from dealers. But you (intentionally) leave out the language that defines a major swap participant as a non-dealer who "maintains a substantial net position” in outstanding swaps, “other than to create and maintain an effective hedge under generally accepted accounting principles".

Which is why I described it as a term essentially describing a dealer or market maker.

And I didn't say that there were 5 derivatives dealers, I said this bill would really only impact the top 5 dealers. If you're running a small derivatives dealing desk, you spin it off. That doesn't cut off your liquidity, nor does it really impact your bottom line at all.

Finally, as far as the "cartoonish" definition of "dealer", while I admit I haven't read the manager's amendment that was reported out of committee yesterday, my understanding is that this definition is actually largely left to the CFTC to determine, precisely to avoid the types of collateral impacts that you blithely and ignorantly assume will effectively cause the entire banking system to lose access to FDIC insurance and Fed liquidity.

Think about what you're claiming. If that's the concern, why are you the only one making it? Because if that were the case, you think that maybe, just maybe, the WSJ and other business media (who are totally behind the banks here) might be making the same claim? Because if you know anything about banking, which it doesn't sound like you do at this point, you'd realize that what you're claiming about the Lincoln bill is that it would effectively undo all of the Banking Acts of the 1930s, cutting off all banks from the Fed window and FDIC insurance.

That's crazy. Your inability to admit you're wrong, either on this or on the SEC charges, is also pretty disturbing.

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