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December 12, 2014

Senator Elizabeth Warren’s battle against repeal of a Dodd-Frank provision requiring big banks to manage their own risks isn’t about right or left, or populism, or pushing the Democratic Party to the left. It’s actually about whether or not we believe in markets; and Senator Warren is on the side of the belief in free markets. Is she trying to endear herself to Tea Partiers and other free market fundamentalists?

At least that is my take away from a fascinating post Don’t Repeal Swaps Push-Put Requirements (Section 716 of Dodd-Frank) at The Baseline Scenario by MIT Economics Professor Simon Johnson.

To give credit not to my interpretation but to Professor Johnson’s view, though, let me quote him: “This is not a left vs. right issue. It is a fundamental systemic risk issue, on which people across the political spectrum who want to lower those risks can agree – Section 716 should not be repealed.”

As Professor Johnson explains the point of Section 716 was to isolate risky financial strategies like interest rate swaps, foreign exchange derivatives, and cleared credit derivatives from the portion of the banks that are federally insured. The insured portion of a bank “is regarded as a better credit (i.e., lower risk) by people in the market precisely because of the federal government-run deposit insurance. Like all better credits, those banks get to borrow at lower costs.” These hedging techniques are still allowable but the banks, not the taxpayers, would need to take the ultimate risk.

But, if the banks not the taxpayers assume the risk, “these speculative derivative positions will be priced by the market based on their actual risk – not mispriced due to the backing of taxpayers.”

"Really this is just taking the state out of subsidizing some of these particularly high risk derivatives. That would be no more than reintroducing the market and market pricing of credit risk."

The magic of the market!

Professor Johnson noted that many conservatives who apparently do believe in markets had called for the provision to remain untouched. But the banks, led by Citibank (about $500 billion in bailouts in 2007-2008), weren’t so interested in the discipline of free markets.

Earlier today my colleague Professor Ubertaccio tweeted this Washington Post article, Congressional Democrats take a stand with spending bill. It was full of the usual insider stuff, who won, who lost, how the bill amendment was bipartisan, etc. It’s highly amusing when Democrats defend their votes on something like this by stating that the public wants them to be bipartisan, here they are working across the aisle, etc. It’s amusing because so many Democrats are in the tank to Wall Street (thanks for those contributions!) that when someone like Senator Warren raises an objection it’s looked upon as aberrant behavior.

Let’s not go too far with this sort of thinking though. If we were to restructure mortgages for working families, it might encourage them to take wild risks. And that would violate our free market ethic.

Elizabeth Warren, congress, Dodd-Frank

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