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Q&A with Kauffman Foundation Economist Robert Litan

If House Republicans succeed in their bid to slash non-defense spending by some $55 billion to $60 billion in fiscal 2011, reforms to the over-the-counter derivatives market might be dead-on-arrival.

If House Republicans succeed in their bid to slash non-defense spending by some $55 billion to $60 billion in fiscal 2011, reforms to the over-the-counter derivatives market might be dead-on-arrival. So says Robert Litan, an economist at the Kauffman Foundation, a Kansas City-based think tank devoted to entrepreneurship. In an interview with Advanced Trading, Litan explains why funding cuts will cause regulators to miss crucial deadlines this summer, lead to weaker OTC derivatives rules, and further expose the markets to systemic risk.

Are the reforms to the OTC derivatives market in danger if the SEC and CFTC's budgets are slashed?

Robert Litan, Kauffman Foundation: Yes. They have deadlines and the agencies are under tremendous pressure to put out not just one but multiple rules all within pretty much the same 18-month timeframe. If they don't have the money to do these rulemakings, they'll certainly miss the deadlines. We may get imperfect rules as a result if they finally do issue the rules.

The first impact will be that they'll just miss the deadlines. The sky doesn't fall if they miss the deadlines by six or 12 months but if you believe, as I do, that the thrust of the rules covering the derivatives markets are important, then the longer we don't have these rules, the more the markets are exposed to systemic risk.

Therefore it's not a good thing to shortchange them on the money. But that clearly is a way for opponents of the regulation to get back at the rules themselves, because the rules are not going to be repealed. So the best way to defame them is to defund them.

Can the regulators do their job with the resources they currently have?

Litan: These agencies already had a lot to do before the law was passed. Then along comes the Dodd-Frank law that basically gives them all of these additional responsibilities. It defies common sense that they can carry out these duties on the same budget. They need more money.

Is the threat of budget cuts merely political posturing by House Republicans? Or is it really unlikely that the regulators will get what they need?

Litan: I think that's right. In the large scheme of things we're not talking about a lot of money. These agencies have budgets of several hundred million dollars. They're not huge tickets given the cost of the crisis. Certainly given the cost of bailing out AIG, or picking up the tab for AIG -- in essence what we're talking about is trying to prevent another AIG. That's what all of these reforms are aimed at.

You take the present discounted value of agency costs that are being devoted to these rule makings. It's a fraction of what we put into AIG. That's the way I look at it. But this is a very ideological space. There are a lot of critics of Dodd-Frank and all the various parts of it. But I would have thought there'd be more consensus about derivatives than anything.

Editor's Note: A more complete version of this interview will appear in the March digital issue of Advanced Trading. As the Senior Editor of Advanced Trading, Justin Grant plays a key role in steering the magazine's coverage of the latest issues affecting the buy-side trading community. Since joining Advanced Trading in 2010, Grant's news analysis has touched on everything from the latest ... View Full Bio

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