Congress has proven that it simply cannot set aside the pressures of those who contribute funds to it. The negotiators for the House-Senate conference committee finished their legislative financial regulatory reform bill Friday morning with a flourish that demonstrates the sheer power of the banking lobby. In Deal, New Authority over Wall Street, NY Times, Jan 25, 2010; Lawmakers reach compromise on Financial Regulation, Bloomberg, June 26, 2010.
There is a consumer protection agency (in the Fed)--but auto dealers are exempt! Given the many anecdotes of auto dealer misleading customers or sheer outright fraud, and the many proprietary practices in auto lending, unconsciounable that the conference committee should have agreed to exempt auto dealers. So anyone buying an auto is not "worth" protecting? Further, although the agency is purportedly independent, its rules can be overridden by the systemic risk council if they are seen to threaten sound banking. Since all consumer protection rules will likely impact to some extent banks' profits (they won't be able to rip consumers off as easily as they have been), it is likely that the council will be predisposed to see the rules as going too far and thus its power to disapprove rules will put a damper on the agency's creation of consumer-protective rules in the first place. This should have been an independent agency, and the idea of "sound banking" should not require allowance for predatory rules.
There is a Volcker Rule limiting proprietary trading--but it was loosened in the negotiations, and of course there is no separation of commercial and investment banking. Banks can provide 3% of the capital of a private equity or hedge fund, and can invest up to 3% of their Tier 1 capital in such entities. (That means, of course, that the bill is permitting banks to have less capital in reserve, since this capital is clearly subject to loss.) this loosened language was offered to appease Scott Brown, Massachusetts Republican, who apparently cared more for State Street Bank's profits than for restoring a stable financial system. At least the ban is clearly spelled out in the legislation, rather than letting regulators define what proprietary trading is and therefore soften the provision even more.
Banks can still get too big to fail, with only the systemic risk council --subject to regulatory capture just like the Fed itself was under Greenspan leading into this current crisis--to draw the line. While there is a risk retention (skin in the game) provision, it has so many exemptions and possibilities for regulatory relief that it cannot achieve its ostensible objective. Most mortgage lenders are exempt and those who sell asset-backed securities can be exempted by regulators.
Although the aftermath of the engineered synthetic CDO deals made it obvious that there is a huge problem when the big banks can create a deal and sell it to trusting clients while betting against it with the bank's (or other people's) money, the weak-kneed Congress kowtowed to industry again and did not include any kind of broker-dealer fiduciary responsibility to clients in the bill. It is up to the sEC to "study" the issue and decide whether to impose such a duty. That's the traditional cop-out when Congress wants to appear to have dealt with an issue but has no intention of acting. As one investment adviser noted, "If this opportunity is missed after the incredible damage Wall Street firms did to our economy, you start to wonder if we will ever see meaningful reform again come to Wall Street." see Investment Advisers Weigh In on Financial Reform Bill, June 25, 2010, Reuters.
The agreement doesn't deal adequately with derivatives and the many "synthetic" products that mimic real production but add nothing to the non-financial productive economy. The $70 trillion notional amount of credit default swaps extant at the height of the crisis were in no small way the cause of the crisis. Credit default swaps mushroomed in a globalized, financialized economy in which to create a tangle of counterparties and risks that regulators ignored or failed to understand and of which even the banksters themselves were uninformed of the full implications for systemic risk. It is foolhardy not to prohibit outright the most synthetic of these derivatives. There should be a ban on use of derivatives to avoid regulatory requirements or to evade taxes. There should be a ban on naked credit default swaps (or else credit default swaps should be regulated as the insurance contracts that they are and require an insurable interest). Swap desks are permitted if banks are hedging risks (they will claim they are hedging whenever they short a deal), or for interest rate and foreign currency swaps; otherwise, swaps desks will be moved to subsidiaries (question whether this is sufficient separation for those liabilities).
" In the end all parties agreed that banks will be able to maintain their trading operations so long as they are used to hedge risk or trade interest rate or foreign exchange swaps, a victory for banks that were on the verge of losing the desks entirely. The proposal will force a fundamental shift in the industry, giving federally insured banks up to two years to send instruments such as un-cleared credit default swaps off to a separately capitalized subsidiary." Bloomberg, op. cit.
While there is improvement in requiring exchange trading and clearing houses for many derivatives trades and corresponding increases in margin requirements, there are huge loopholes in the bill as agreed. Business users are exempt fromclearing requirements if they are hedging a legitimate business risk (leaving pricing structures hidden and of course creating an interface for manipulation through regulatory arbitrage). Regulators MAY increase capital requirements or limit the size of a trader's swap book, but as we have seen in this current crisis, regulators may be reluctant to impose discretionary limits not required in the legislation.
Banks get a very long transition period to ditch their TrUPs funding for direct equity funding--5 years for big banks; 20 years for community banks! (We may already be in a followup financial crisis by that time.)
There will be a one-time audit of the Fed, but no full audit of interest rate decisions and other matters. The Fed will continue on its powerful path.
Casino banking, that is, survived . Financial innovation is a social waste, but Congress can't seem to recognize that reality. This is in keeping with the mainstream economic perspective that markets are really "efficient" in spite of what appear to be problems and that just a little more transparency will take care of the problem. See, e.g., Seidenberg, Chair of the Business Roundtable, speech to the Economic Club of Washington, June 22, 2010 (arguing that regulatory form that tinkers with derivatives could be disastrous, while of course arguing that corporate taxes need to be cut to assist corporations in competition, etc. etc. etc.)
We see a host of laws, regulations and other policies being enacted that impose a government prescription of how individual industries ought to be structured, rather than produce an environment in which the private sector can innovate, invest and create jobs in this modern global economy.
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we believe some of the current proposals with respect to derivatives and proxy access go a step too far, imposing one-size-fits-all solutions on highly dynamic and diverse businesses. Instead of focusing on the inputs to a transparent and efficient financial system, the proposed reforms will increase risk and volatility at a time when just the reverse is required
See also the Business Roundtable's letter to the Budget Director on "Policy Burdens Inhibiting Economic Growth" June 21, 2010 (same old request for low taxes, nonregulation, etc )
The legislative result in not surprising, furthermore, since Obama's team of Summers and Geithner were key supporters for the disastrous deregulatory banking agenda under Clinton, and in particular for the commodities futures modernization act, which declared derivatives out of bounds to all banking regulators. That let the casino mentality roar into super-gear, as banks developed financial products to avoid taxes, avoid regulation and push fungible transactions around the globe in a network of interconnected credit tangles that brought the global economy down.
You'd think that Congress would get it. The Street should be treated as a wild beast that must be tamed. Instead, Congress is poking its hand through the cage to give it one more treat, with hopes that it will recuperate to be its same old hugely profitable casino-betting self in no time. That means there will be another crash, as bad as the Great Recession or worse, because we will not have the funds available to deal with it after the huge hit from this one.
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