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The too-big-to-fail problem is getting even bigger
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(Daniel Goodman / Business Insider)
The too-big-to-fail problem on Wall Street may now be even bigger.
The Dodd-Frank Act was implemented in response to the financial crisis to make sure a bank's failure didn't risk bringing down the entire financial system.
But according to Craig Donohue, the executive chairman of The Options Clearing Corporation and the former CEO of the Chicago Mercantile Exchange, the law may have made things worse.
"One of the unfortunate things that I think is happening as a result of Dodd-Frank is they were trying to solve too-big-to-fail problems, but, in some sense, I think they've made things even bigger, certainly from the bank perspective," Donohue told Business Insider in a recent interview.
Specifically, Donohue said that Dodd-Frank had caused the industry to become a "very, very capital-intensive business" and that operating expenses were "between two and three times what they have been historically."
Dodd-Frank called for the designation of some companies as systemically important financial institutions, or companies that could pose a threat to the stability of the US financial system. Aside from the designation of financial institutions as systemically important, financial utilities were also included.
The introduction of Dodd-Frank, along with other rules such as Basel III Capital Accord, has made trading on central counterparty clearing exchanges much more expensive.
During the crisis, centrally cleared markets, or those that are cleared by a single entity, functioned as normal, in part because people had faith they would be made whole on their trades. On the other hand, over-the-counter markets seized up because nobody knew whether their counterparty would survive.
(Options Clearing Corporation chairman Craig Donohue.Options Clearing Corporation)
The unfortunate thing, Donohue said, is that now it's "more expensive to clear through a central counterparty than it may be to maintain a bilateral credit exposure between two financial institutions." And that could be a danger to the financial system.
"I'm actually pro-regulation, and I think some of these create scrutiny and regulation of central counterparties is actually good for us, but not to the extent that we've basically subverted the policy goals of the international regulatory community and the outcome is sort of upside in the way that I've described," Donohue said.
The two global regulators who oversee the derivatives market earlier this week sounded the alarm on the industry responsible for clearing derivatives, saying that some had no guidebook to follow if they get into financial trouble.
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