6/09/2011

When politicians don't understand how contracts work

Frank-Dodd is doing huge damage to the economy. If you want one simple example, here is a piece in today's WSJ.

Last summer, Congressman Barney Frank and then-Senator Chris Dodd stayed up all night writing new rules for America's multitrillion-dollar derivatives markets. The reforms were sold as punishment for Wall Street, but Main Street woke up to new regulations that are giving corporate treasurers headaches. Now all market participants could be suffering from a wicked legislative hangover come July 16.

According to the Dodd-Frank law, that's the day when the old legal regime for so-called swaps contracts must expire. As the name implies, swaps are contracts in which two parties agree to exchange, say, a fixed interest rate for a floating one, or an obligation to pay in dollars for a commitment to pay in euros. The use of such products has exploded as companies try to reduce their financial risks while focusing on their core business. Caterpillar wants to spend its time making bulldozers, for example, rather than guessing about currency movements in every country where it sells equipment.

But even the regulators now acknowledge that there's no way they will be able by July 16 to finalize all the new rules that are supposed to replace those destroyed by Dodd-Frank. So what happens to all these swap deals? Legal opinions differ on whether parties on the losing side of such contracts will be able to sue and have them declared null and void.

A 2000 law clarified that swaps were not considered futures contracts, which by law must trade on exchanges. But by knocking out the 2000 law and replacing it with nothing, Dodd-Frank made it possible for a judge to rule that over-the-counter swaps are now illegal futures contracts, and therefore invalid. This latest Dodd-Frank gift to the U.S. economy could throw into question all existing swaps trades. The stakes are enormous given that these markets have a notional value of close to $600 trillion. . . .

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