Senator Chris Dodd’s monstrous 1336-page financial reform draft includes a whopping 217 pages devoted to “improving” over-the-counter derivatives markets. Dodd the derivatives section may be replaced by a yet-to-be-released bipartisan compromise from Senators Jack Reed and Judd Gregg. But the Dodd draft suggests that legislators are focused on bureaucratic imperatives rather than improving markets.
The biggest blind spot in Dodd’s draft is the assumption that only command and control regulation can improve markets. In fact, beginning even before the financial crisis, an international cooperative effort of derivatives market participants led by the New York Federal Reserve has led to significant improvements in the market.
Over the past 18 months, while Washington dithered, derivatives market participants standardized derivatives products, implemented central clearing, began informational reporting to the public and regulators, and are exploring exchange trading. The Dodd draft is written as if none of this ever happened, perhaps for no better reason than that the steps were not mandated from Washington. In fact, Dodd calls on the industry to achieve just these steps six months or a year after his bill is passed (assuming that ever happens).
Having Washington pile on now with more regulations will only disrupt what the markets have already achieved, and freeze progress in late 1998 when the concepts in the Dodd draft were first floated.
Even assuming derivatives require more regulation, Dodd’s second mistake is fixating on who gets the job rather than how it is done. Differing types of derivatives have attributes akin to securities, futures, insurance, and banking products. Derivatives confound jealously-guarded jurisdictional boundaries in existing bureaucracies and, even more disconcertingly for legislators, in Congress.
Dodd proposes a classic Washington compromise: decide not to decide. The Dodd draft solves the jurisdictional conundrum by giving joint jurisdiction over derivatives to two Washington-based agencies: the Securities and Exchange Commission and the Commodity Futures Trading Commission. Disputes between the agencies are to be resolved by a new regulatory council composed of representatives of those two and yet other financial regulatory bodies.
In other words, if two commissions with ten commissioners can’t solve the problem, Congress will call in … even more commissions and agencies.
What’s puzzling is why Dodd ignores the one agency that (a) has experience in regulating derivatives trading and (b) has actually fostered recent major derivatives market improvements: the Federal Reserve Bank of New York.
It’s not as if Dodd is unaware of the New York Fed: his draft proposes to make the Chair of the Bank a Presidential appointee subject to Senate confirmation.
There’s no reason for Congress to add another layer of regulation on to this market. Cranking up regulation could in fact make things worse by disrupting the positive changes already taking place. Bureaucrats will disrupt productive markets self-corrective processes and result in unintended consequences. But if Congress does intervene, any steps should reflect the current state of the derivatives markets, not where they stood two years ago. And Congress should give any regulatory authority to an agency with a proven track record at improving markets, rather than creating a gridlock-prone dual-headed scheme.
In a time when the usage of the word “bipartisan” spawns cynicism among taxpayers across the 50 states, a recent bipartisan Senate bill stands out as an exception. “The Bipartisan Tax Fairness and Simplification Act of 2010,” introduced by Senators Ron Wyden (D-OR) and Judd Gregg (R-NH), is a serious bipartisan effort to overhaul our current tax code that most economists and business people agree constitutes one of the most damaging drags on U.S. competitiveness and economic recovery.
To succeed, Wyden and Gregg will need to swim against a tide of populist anti-corporate dogma and convince their colleagues to make the necessary adjustments to keep our economy competitive and flexible. Considering the fact that our nation has stood almost alone in having resisted tax reforms, and currently has the second highest corporate tax rate among advanced nations, tax reform is an urgent priority for promoting fairness and efficiency in our economy, restoring our economic freedom, and increasing prosperity.
America’s complex and investment-squashing tax code is a major factor in reducing our score in the Heritage Foundation’s Index of Economic Freedom. As the 2010 Index reveals, since July 2008 more than 30 countries have introduced reforms in direct taxes or have implemented tax cuts as previously planned, despite the challenging economic and political environment caused by the global economic slowdown. The United States is not one of these countries. Not surprisingly, in light of such inaction (and other policy mistakes over the last year, our economy fell out of the top tier of “free” economies in the 2010 Index.
The Wyden-Gregg Bipartisan tax reform bill contains many solid proposals that would effectively overturn years of policy inaction and poor policy choices by the U.S. Congress and restore our economy on the path of economic freedom. One of the key features of the bipartisan tax reform bill is the introduction of a flat corporate tax rate of 24 percent, a significantly reduced rate from current 35 percent. If enacted, the new corporate tax rate would improve our Index fiscal freedom score by at least 6.5 points, and perhaps even more in light of the regulatory simplification and overall reduction of the tax burden that would ensue.
What does this score increase practically mean to our economy? The improvement in fiscal freedom triggered by a noticeably lower corporate tax rate could generate more than 300,000 additional manufacturing jobs and a rise of total employment by over 2 million by the end of this decade, as indicated in a recent Milken Institute study. Most importantly, if combined with other reform measures such as meaningful spending cuts, tax reform would enhance our overall economic freedom to a far greater degree, paving a genuine path towards restoring our economy as a “free” economy and creating more dynamic job creation.
While many economies around the world continue on the path of increasing competitiveness and flexibility, the U.S. has recently been moving in the opposite direction, simultaneously eroding our economic freedom with uncompetitive tax rates and ever increasing government spending, hampering dynamic private investment and retarding economic recovery. More than ever, it is the time to reverse the slide in our economic freedom. A good stepping stone to that would be to make bipartisan tax reform a reality.