University of Houston Finance Professor Craig Pirrong detailed several "fundamental flaws" in the Dodd-Frank Act and consequent adverse effects on the financial markets. In a speech at the FOW (Global Investor Group) Trading event in Chicago (and in a recent blog post) Professor Pirrong provided an analysis of these effects.

  • Too big to fail: Professor Pirrong argued that a significant objective of Dodd-Frank was to combat "too big to fail," but aspects of the legislation are actually favorable to larger-scale entities including the imposition of certain significant, fixed compliance costs. Further, contrary to the legislative intent, Dodd Frank has created excessive concentration of futures commission merchants, which results in additional systemic risk.
  • Clearing and collateral mandates: Professor Pirrong claimed that clearing and collateral mandates were implemented in order to reduce the amount of credit from over-the-counter derivatives transactions. However, he argued, these mandates "increase demand for liquidity precisely during those periods in which liquidity supply typically contracts." He stated: "[t]he fundamental problem [with Dodd-Frank] is inherent in the super-sizing of clearing and margining, and that problem is here to stay."
  • Position limit rule and swap execution mandate: Professor Pirrong criticized position limit rules proposed by the CFTC:

"It is sickly amusing that the CFTC touts that based on historical data, the proposed limits would constrain few, if any market participants. In other words, an entire industry must bear the burden of complying with a rule that the CFTC itself says would seldom be binding."

Professor Pirrong also criticized the swap execution facility mandate, and asserted that such regulations impose additional compliance costs, reduce competition and harm liquidity.

Commentary / Bob Zwirb

Translation: Even if you had a handful of Nobel prize winning regulatory economists in charge of implementing the Dodd-Frank derivatives reforms, you would still have a bad outcome. That is, even if you had George Stigler, Ronald Coase, Friedrich August von Hayek, Gary Becker, Milton Friedman, James Buchanan, and Merton Miller in charge of running the show at the CFTC, they would still not be able to overcome the fundamental flaws in the statute. That thesis, however, contrasts with the official view today in Washington; i.e., that the problem is not the statute itself, but with the way it's being implemented.

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