Closing loopholes

By Felix Salmon
December 10, 2009
Remember how Gary Gensler persuaded Barney Frank to close a big loophole in the derivatives-regulation legislation? I was hopeful then -- poor, naive soul that I am -- that the banking lobby had been effectively neutered on the loophole front.

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Remember how Gary Gensler persuaded Barney Frank to close a big loophole in the derivatives-regulation legislation? I was hopeful then — poor, naive soul that I am — that the banking lobby had been effectively neutered on the loophole front.

Of course it hadn’t: it just started looking for another loophole instead. Remember that the main point of the legislation is to force all derivatives trading onto an exchange. The first loophole tried to get around that by saying that “end users” could get a pass; inevitably, all the major banks would somehow manage then to define themselves as end users.

The new loophole, as explained by Mike Konczal, takes another tack. It says that you don’t need to trade derivatives on exchange — you just need to trade them on an exchange or a “swap execution facility”. And then it defines “swap execution facility” so broadly that two traders talking on the telephone — just like they do in the current OTC market — can be considered such a thing.

There’s been enough publicity surrounding this loophole that it might yet get closed. But the bigger picture is clear: Wall Street, in the pursuit of large profits, will always try to find a way around regulations it doesn’t like. And eventually it’s going to succeed. Which is one reason why we need a more principles-based approach to regulation. Rules always grow loopholes.

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