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Fixing the Regulatory Framework for Derivatives

The mere mention of derivatives is usually enough to end any rational discussion of financial regulation. Though many policymakers have strong opinions on the apparent dangers of derivatives, there is no objective economic reason to regulate derivatives as a unique product. Yet, Dodd–Frank took exactly that approach, leaving financial markets with a higher concentration of financial risks and a complex set of rules filled with special exemptions. Worse, Dodd–Frank did essentially nothing to address the main problem with the existing regulatory framework: Derivatives users receive special exemptions from core bankruptcy provisions. The current bankruptcy code was enacted in 1978, and Congress has steadily expanded special exemptions (safe harbors) for derivatives and repurchase agreements (repos), as well as other financial contracts. These safe harbors were typically justified as necessary to mitigate systemic risk, but the 2008 crisis showed that these arguments are deeply flawed. To improve the regulatory framework for derivatives, Congress should remove all bankruptcy safe harbors for derivatives and repos, and repeal Title VII of Dodd–Frank.

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