De Minimis Logic


CFTC Chair Timothy Massad has come out in support of a one year delay of the lowering of the de minimis swap dealer exemption notional amount from $8 billion to $3 billion. I recall Coase  (or maybe it was Stigler) writing somewhere that an economist could pay for his lifetime compensation by delaying implementation of an inefficient law by even a day. By that reckoning, by delaying the step down of the threshold for a year Mr. Massad has paid for the lifetime compensation of his progeny for generations to come, for the de minimis threshold is a classic analysis of an inefficient law. Mr. Massad (and his successors) could create huge amounts of wealth by delaying its implementation until the day after forever.

There are at least two major flaws with the threshold. The first is that there is a large fixed cost to become a swap dealer. Small to medium-sized swap traders who avoid the obligation of becoming swap dealers under the $8 billion threshold will not avoid it under the lower threshold. Rather than incur the fixed cost, many of those who would be caught with the lower threshold will decide to exit the business. This will reduce competition and increase concentration in the swap market. This is perversely ironic, given that one ostensible purpose of Frankendodd (which was trumpeted repeatedly by its backers) was to increase competition and reduce concentration.

The second major flaw is that the rationale for the swap dealer designation, and the associated obligations, is to reduce risk. Big swap dealers mean big risk, and to reduce that risk, they are obligated to clear, to margin non-cleared swaps, and hold more capital. But notional amount is a truly awful measure of risk. $X billion of vanilla interest rate swaps differ in risk from $X billion of CDS index swaps which differ in risk from $X billion of single name CDS which differ in risk from $X billion of oil swaps. Hell, $X billion of 10 year interest rate swaps differ in risk from $X billion of 2 year interest rate swaps. And let’s not even talk about the variation across diversified portfolios of swaps with the same notional values. So notional does not match up with risk in a discriminating way.  Further, turnover doesn’t measure risk very well either.

But hey! We can measure notional! So notional it is! Yet another example of the regulatory drunk looking for his keys under the lamppost because that’s where the light is.

So bully for Chairman Massad. He has delayed implementation of a regulation that will do the opposite of some of the things it is intended to do, and merely fails to do other things it is supposed to do. Other than that, it’s great!