Overwhelming a Financial Regulatory Black Hole with Legislative Sunlight: Dodd-Frank’s Attack on Systemic Economic Destabilization Caused by an Unregulated Multi-Trillion Dollar Derivatives Market
Journal of Business & Technology Law, Vol. 6, No. 1, p. 127, 2011
Posted: 25 Feb 2011 Last revised: 28 Apr 2011
Date Written: 2011
It is now accepted wisdom that it was the non-transparent, poorly capitalized and almost wholly unregulated over-the-counter (“OTC”) derivatives market that lit the fuse that exploded the highly vulnerable worldwide economy in the fall of 2008. Because tens of trillions of dollars of these financial products were pegged to the economic performance of an overheated and highly inflated housing market, the sudden collapse of that market triggered under-capitalized OTC derivative guarantees of the subprime housing market; and the guarantors’ multi-trillion dollar interconnectedness with thousands of other OTC derivatives’ counterparties within that OTC market (through interest rate, currency, foreign exchange, and energy derivatives) required taxpayers to plug the huge capital holes that cascading nonpayment would have caused, thereby leading the world’s economy to crater.
As it now stands, the world is still in the midst of the worst financial crisis since the Great Depression of the 1930’s. This article explains the history of derivatives products, including the highly charged political events surrounding deregulation of these huge financial markets even in the face of mounting evidence of the danger that those unregulated instruments could cause the U.S. and world financial system. The article then provides an overview of how recent Congressional OTC derivatives financial reform - Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) - will substantially mitigate those risks if properly implemented by federal regulators, while at the same time allowing financial markets to thrive through ensuring capital adequacy, transparency and liquidity. The article ends with a vision for what the financial system would look like if Dodd-Frank is implemented as its drafters intended.
Keywords: derivatives, OTC, Dodd-Frank Wall Street Reform and Consumer Protection Act
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