Making Derivatives Less Integral

The Senate Agriculture Committee just passed a bill regulating the derivatives market. Summary here. The legislation imposes clearing and trading requirements and real-time reporting of derivatives trades. It provides exceptions for some businesses like electric cooperatives which have argued that hedging business risks are important. It also tackles the moral hazard problem that the possibility of bailouts creates. (That is, if banks feel that the government will bail them out when they lose money, they take more risks since the downside is smaller for them). If the bill becomes law, the Federal Reserve Board and the Federal Deposit Insurance Corp. will be prohibited from providing any federal funds to businesses who are involved in derivative deals. This seems to imply that banks engaging in naked swaps transactions would have to spin off their swap dealer desks or be out in the cold in a crisis when others might be receiving bailouts. Of course, in a  crisis, laws change, and if no one spins off their desks, we are unlikely to let all banks go under (see Fall 2008).