Will the 'Cure' for Systemic Risk Kill the Economy?

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What cancer research can teach us about how to reform the derivatives market

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"I do not know whether the elderly woman died from cancer or its cure." - Dr. Siddhartha Mukherjee, author of "The Emperor of All Maladies"

Some medicines powerful enough to cure also hold the power to kill. That's why carefully selecting drugs and properly calibrating their doses are essential disciplines in the treatment of an illness. There are three ways in which early successes in combating diseases like cancer can offer important insights to financial policymakers tasked with implementing reforms to mitigate systemic risk.

First, too much of even the right medicine will kill patients -- just as excessive amounts of well-intentioned regulation will hamper economic activity. Second, remedies need to be carefully formulated to address the severity of a particular illness -- and new derivatives rules should be calibrated to the losses that could reasonably be expected in a severe financial crisis. Third, treatment should attack only the cancerous cells, not the healthy tissue -- in a similar sense, regulation should focus on firms where their derivatives use poses systemic risk, while leaving other firms untouched.

This week, the comment period ends for some important new rules that will govern derivatives. As regulators finalize the regulatory framework, they can learn from commonly accepted medical principles. Ignoring them could significantly harm economic growth -- diverting trillions of dollars from productive economic use. Emil Freireich, an early cancer research pioneer who was part of the team at the National Cancer Institute ("NCI") that successfully cured childhood leukemia in the early 1960s, highlighted one such lesson in recalling the initial use of a potent experimental drug regimen: "The doses we gave her were too high, and she almost died of toxicity...By not recognizing when to stop, the first patient got two extra days of chemotherapy and that was the thing that almost killed her."

In a speech before the International Monetary Conference earlier this month, Treasury Secretary Tim Geithner exhorted world governments to adopt a global standard for margin requirements in the derivatives market. Such requirements, recently proposed by U.S. regulators, will govern how much cash companies need to set aside against their derivatives trades. Because this cash -- an amount which could exceed annual federal tax receipts -- would otherwise be available to invest in the economy, it is critical that U.S. regulators properly calibrate their rules before attempting to export them around the globe.

If margin rules are excessive or apply to firms that pose no risk to financial stability, they will blunt economic growth and job creation without proportional benefit.

These rules influence the cash resources businesses are able to invest in new plants and equipment, loan to small businesses, and dedicate to research and development. They will also affect the prices of everyday products like airline tickets, cereal, and life insurance. If margin rules are excessive or apply to firms that pose no risk to financial stability, they will blunt economic growth and job creation without proportional benefit.

As financial policymakers work to insulate the economy from future threats, they face significant challenges. Chiefly, they must craft policies that target a problem -- systemic risk -- about which they understand little and which is constantly evolving. Federal Reserve Chairman Ben Bernanke acknowledged this recently when he said, "...much work remains to better understand sources of systemic risk, to develop improved monitoring tools, and to evaluate and implement policy instruments to reduce macroprudential risks."

While significant, these obstacles are not insurmountable. By examining medical disciplines like cancer research that also faced huge challenges, policymakers can increasingly target the sources of systemic risk in ways that do not unnecessarily burden the economy.

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Luke Zubrod is a director at global risk management advisor Chatham Financial, an advisor to over 1,000 end users of derivatives.  His grandfather, C. Gordon Zubrod, led the National Cancer Institute's early efforts to cure cancer. More

Zubrod leads Chatham's government and regulatory advisory team, advising public and private companies on over-the-counter derivatives regulations. He has actively participated in the public policy debate on derivatives regulation, testifying before Congress and providing advice and recommendations to congressional staff and to staff of various regulatory agencies. Over the last decade, Zubrod has advised CFOs and treasurers across a wide range of industries on managing their interest rate and currency risks, most recently leading Chatham's advisory practice to U.S. public real estate companies. Prior to joining Chatham, Zubrod worked as a management consultant at Deloitte. He lives in Kennett Square, Pennsylvania with his wife and three kids.
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