The Summer issue of Morgan Stanley’s Journal of Applied Corporate Finance has a number of interesting articles on “Fixing the Financial System”. One by Craig Pirrong of the University of Houston examines in detail the many issues arising from the Dodd-Frank law’s mandate for the clearing of OTC derivatives. Among other things. Pirrong highlights the many choices at hand in the implementation of the mandate, and how difficult it will be to assure that the goal of reducing aggregate credit exposure is realized. These choices are real, and Pirrong is correct that how the mandate is implemented can make a big difference on whether the goal is accomplished. These points are well taken and need to be seriously addressed by the CFTC and the SEC as the rules for implementing the law are written.
While we have been supportive of the mandate, Pirrong is, at best, a skeptic. He acknowledges that clearing could potentially reduce aggregate credit risks in the system, thereby lowering costs to end-users. But for a variety of reasons he has more faith that unregulated bankers will get closer to the cost minimizing result than a system partially shaped by government regulations.