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Why Banks Shouldn't Control Clearinghouses

In my post yesterday about derivatives, I mentioned the importance of "clearing," which would help sever the interconnections between firms on either side of a derivatives trade. (The interconnections are what can put the whole financial system at risk when one firm, like Lehman, runs into trouble.)

But one of the problems with clearing is that it requires clearinghouses, which are privately-owned entities that end up with a lot of power to influence the way derivatives get regulated. Worse, the clearinghouses are often partly owned by big banks--the same institutions that are typically the target of the regulations. Gretchen Morgenson sketched out the obvious conflict of interest in this recent column.

What to do about this? Over at Rortybomb, the indispensable Mike Konczal makes the case for the Lynch amendment, the brainchild of Massachusetts Rep. Stephen Lynch. Here's the amendment's key passage:

The rules of a clearing agency that clears security-based swaps shall provide that a restricted owner shall not be permitted directly or indirectly to acquire beneficial ownership of interest in the agency or in persons with a controlling interest in the agency, to the extent that such an acquisition would result in restricted owners controlling more than 20 percent of the votes entitled to be cast on any matter by the holders of the ownership interests.

Translation: No one could own more than 20 percent of a clearinghouse, which means that no owner would control its decisions about which derivatives to clear. As Konczal notes, "[t]his amendment should move you if you believe (a) the largest banks have a concentration of political power and need to be curbed and (b) the government should be in the business of defending markets, not big businesses." Which means that, while it should attract supporters on both left and right, it's going to arouse a whole lot of opposition among the big banks. In fact, they've apparently already labeled the Lynch amendment "anti-competitive." Go figure.