CLIFFORD ASNESS AND AARON BROWN: THE TREASURY-FINANCIAL COMPLEX
OPINION
MAY 13, 2010
The Treasury-Financial Complex
The Dodd bill is perfectly designed to create the largest and most powerful crony system in history.
By CLIFFORD S. ASNESS AND AARON BROWN
Whatever your views on financial reform—whether you want the government to crack down on bankers or to disentangle itself from financial markets—you should fear Sen. Chris Dodd’s financial reform bill. In 1,300-some pages, all it really does is legislate power to the government for fixes to be named later. It does this by using terms that are either totally undefined or defined in breathtaking generality.
This is a politically understandable solution. But it sweeps aside more than two centuries of accumulated wisdom: that checks and balances are essential to markets, and that rules must be known in advance.
Here’s one example: In the bill, a “swap” is defined as “any contract or transaction that has financial, economic or commercial consequence involving purchase, sale, payment or delivery with any contingent clause.” We challenge lawmakers to think of any contract or transaction that doesn’t meet that definition—from buying detergent with a money-back guarantee to getting a rain-check at the car wash. If you maintain a “substantial” net position in swaps, or if your failure to perform under your swaps could cause “significant” losses, you are considered a “major swap participant.” And you really don’t want to be one considering how you’ll be regulated.
“Substantial” and “significant” are never defined. The bill does not say whether they are to be measured relative to the global economy, or the financial positions of you and your counterparty, or for that matter to the average humidity of a mid-summer afternoon in Cleveland. All of this is to be named later.
The bill also requires “major swap participants” to forfeit privacy and freedom. They are required to register and “to report and furnish to the Commission such information pertaining to . . . [their] business as the Commission may require.” The Commission “may prescribe rules applicable to . . . major swap participants” without significant limitation. No one has to notify you in advance and you’re supposed to figure out for yourself which rules apply to you. Guessing incorrectly could land you in prison.
The issue of “major swamp participants” is one example in a bill that is filled with terms and clauses so ambiguous as to allow virtually any government action.
Our company, AQR Capital Management, trades swaps. We are already registered with the SEC and have no objection to providing information to regulators. We support anything to make the swap market more transparent and safer, because that helps both our business and the country. So we don’t have any qualms about a bill intended to do that. What we have a problem with is that the bill is drafted so it can do anything.
True, if this bill is enacted we doubt that federal agents will nab you if you accept a rain check from the car wash without registering. Regulators will restrict information requests and rules to things obviously related to financial trading. So, except for a few constitutional scruples, what’s the harm with giving regulators this blank check?
Regulators will likely start off reasonably. But soon they’ll be pressured to investigate all unpopular financial events, using their unlimited power to demand information. And because they have unlimited power to set rules they will be able to outlaw practices as they see fit. This will encourage anyone who loses money for any reason to use political pressure to get redress.
Regulatory staff will be working constantly with private-sector counterparts. People who play ball with regulators can count on favors and subsidies for themselves and barriers for their competitors and enemies.
This will be a two-way capture. Regulated institutions will get fat on government-legislated profit, and regulators will look good by getting private firms to throw money at any problem that bothers Congress. People will move back and forth between the private and regulatory sectors.
The Dodd bill is perfectly designed to create the largest and most powerful crony system in history. It’s not that the people, regulator or regulated, are personally corrupt. It’s that the system will itself select for, reward and enforce corruption.
No financial professional will be able to turn down a “request” for a campaign contribution, and all financial institutions will hire former staffers as advisers or directors. No regulator can afford to antagonize a potential future employer. Regulators themselves must kowtow to Congress, which can use them for under-the-table subsidies to favored groups. None of this is new to politics, of course, but the scale and lack of defined powers are.
Reforms should be packaged into simple laws that do not require enormous discretion to administer. Good ones work best this way, and bad ones have limited ability to do harm and can be repealed. Instead, the Treasury-financial complex that the Dodd bill creates will be as expensive and hard to kill as the military-industrial complex President Eisenhower advised us to fear.
Mr. Asness is a managing and founding principal of AQR Capital Management. Mr. Brown is risk manager at AQR Capital Management.
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