Ezra Klein has an extensive interview with Senate Banking Committee Chair Chris Dodd, a key architect of the financial-reform legislation, that is well worth your time to read. Here's a taste:
EK: A lot of what you say, when you say it's not size but interconnectedness, seems to be a critique located in the derivatives market. That's where the interconnectedness comes, that's where the complexity is. What are your bright lines on derivatives?
CD: Let the market work. I've had people tell me that had the market known about the financial products division of AIG, that that wouldn't have lasted 30 seconds. But they didn't. It was the shadow economy. So a lot of sunlight, a lot of transparency, ought to be the presumption as you're looking at this. I believe if people can see what's going on, then the markets will react to this stuff. Now I accept the notion that there are certain derivatives where there just isn't a volume in what you're dealing with here that it probably doesn't need to be on an exchange. But I like the idea of a presumption of an exchange, because the exchange is where I get the sunshine on this. And if markets are reacting as they ought to be, they'll have their own way of pricing these products or rejecting them because of their shortcomings or their weaknesses.
The problems caused by a simple lack of market transparency in derivatives deals were huge and really drove the 2008 crisis and the bailouts that followed. Dodd's position is market-friendly, but the reason actual market participants, particularly the five megabanks that control most of the derivatives traffic, are skeptical of this kind of transparency is simple: They make a lot more money having a monopoly and keeping most derivatives purchasers in the dark about what their competitors can offer them -- and perhaps many other things, as we see in the Goldman Sachs SEC case -- and thus can increase profit margins.
By bringing these markets into a proper trading facility, you'll see increased competition to provide the best deals, which is a net loss for the largest banks but a win for competition and the economy as a whole.
-- Tim Fernholz
