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One Safety Net That Needs to Shrink

ELECTION Day is upon us, and neither President Obama nor Mitt Romney has really addressed one of the nationu2019s most pressing economic issues: the risk that one day taxpayers might have to bail out swashbuckling financial institutions again.

Election Day is upon us, and neither President Obama nor Mitt Romney has really addressed one of the nation’s most pressing economic issues: the risk that one day taxpayers might have to bail out swashbuckling financial institutions again.

Granted, the economic pain many are feeling now — the snail’s pace recovery, the stubbornly high unemployment — is foremost in voters’ minds. But given all we’ve gone through after the last binge in the financial industry, failing to confront the too-big-to-fail question is a serious oversight.

Many Americans probably think the Dodd-Frank financial reform law will protect taxpayers from future bailouts. Wrong. In fact, Dodd-Frank actually widened the federal safety net for big institutions. Under that law, eight more giants were granted the right to tap the Federal Reserve for funding when the next crisis hits. At the same time, those eight may avoid Dodd-Frank measures that govern how we’re supposed to wind down institutions that get into trouble.

In other words, these lucky eight got the best of both worlds: access to the Fed’s money and no penalty for failure.

Which institutions hit this jackpot? Clearinghouses. These are large, powerful institutions that clear or settle options, bond and derivatives trades. They include the Chicago Mercantile Exchange, the Intercontinental Exchange and the Options Clearing Corporation. All were designated as systemically important financial market utilities under Title VIII of Dodd-Frank. People often refer to these institutions as utilities, but that’s not quite right. Many of these enterprises run lucrative businesses, have shareholders and reward their executives handsomely. Last year, the CME Group, the parent company of the Chicago Mercantile Exchange, generated almost $3.3 billion in revenue. Its chief executive, Craig S. Donohue, received $3.9 million in compensation and held an additional $10 million worth of equity awards outstanding, according to the company’s proxy statement.

Make no mistake: these institutions are stretching the federal safety net. The Chicago Merc clears derivatives contracts with a notional value in the trillions of dollars. I.C.E. clears most of the credit default swaps in the United States — billions of dollars a day, on paper. No wonder they are considered major players in our financial system.

But placing them at the bailout trough is wrong, according to Sheila Bair, the former head of the Federal Deposit Insurance Corporation. In a recently published book, Ms. Bair wrote that top officials at the Treasury and the Fed, over the objections of the F.D.I.C., pushed to gain access for the clearinghouses to Fed lending.

The clearinghouses “were drooling at the prospect of having access to loans from the Fed,” she wrote. “I thought it was a terrible precedent and still do. It was the first time in the history of the Fed that any entity besides an insured bank could borrow from the discount window.” .

“The Treasury’s and the Fed’s reasoning was that since another part of Dodd-Frank was trying to encourage more activity to move to clearinghouses, we should provide some liquidity support to them,” she said in an interview last week. “Our argument back was, if you have an event beyond their control with systemwide consequences, then you have the ability to lend on a generally available basis. What they wanted was the ability to lend to individual clearinghouses.”

The clearinghouses have considerable clout in Washington. From the beginning of 2010 through this year, the CME Group has spent $6 million lobbying, according to the Center for Responsive Politics.

Did these players push for special treatment while avoiding other aspects of Dodd-Frank? Representatives of the Chicago Mercantile Exchange and the Options Clearing Corporation say no, noting that access to the Fed meant they would also be overseen by the central bank, in addition to the Securities and Exchange Commission or the Commodities Futures Trading Commission.

But the Fed’s involvement is not likely to be intrusive, because Dodd-Frank directed it to take a back seat to a financial utility’s primary regulator, either the S.E.C. or the C.F.T.C.

The CME said that it did not support Dodd-Frank’s designation of clearinghouses as systemically important, but once it received the designation, it believed the Fed should provide access to emergency lending. The O.C.C. echoed this point.

Whatever the case, the CME Group has argued that it should be exempt from the orderly liquidation authority set up under Dodd-Frank. This authority was designed to unwind complex and interconnected financial firms that could threaten the financial system if they failed. The law appointed the F.D.I.C. as receiver to resolve teetering entities. That authority is supposed to end the problem of institutions that are too big to be allowed to fail and also to hold their managers accountable.

BUT in a letter to the F.D.I.C. a few months after Dodd-Frank became law, the CME Group asked the F.D.I.C. to confirm that the exchange wouldn’t fall under that authority’s jurisdiction. It is not a financial company as defined by the law, the CME contended, and therefore should not be subject to the resolution process.

The F.D.I.C. has not confirmed the C.M.E.’s view on the matter. But it seems to be gaining traction among other regulators. At an Aug. 2012 presentation last August on resolving financial market utilities, Robert S. Steigerwald of the Federal Reserve Bank of Chicago noted that it was unclear whether a financial utility such as the Chicago Merc would have to be wound down as required under Dodd-Frank.

So these large and systemically important financial utilities that together trade and clear trillions of dollars in transactions appear to have won the daily double — access to federal money, without the accountability.

“Dodd-Frank should have been all about contracting the safety net,” Ms. Bair said last week. “But this was a huge and unprecedented expansion of the safety net that provided expressed government support for for-profit entities. These financial market utilities are the new government-sponsored enterprises.”

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