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Key FinReg Components Under Threat

Mike Konczal (who I had the pleasure of meeting at the America’s Future Now conference) has written a report outlining his dream scenario for the Wall Street reform conference committee, coming up with the best of both the House and Senate bills. He has four topic headings:

Making Resolution Authority Credible
Getting Our Banks Capitalized
Bringing Derivatives Into the Sunlight
Audit the Fed

The graphic at the top basically gives you the thumbnail sketch for Konczal’s main concerns (If you want a larger outline of the differences between the House and Senate bills, here’s a great comparison). I like how he made Section 716 and the Volcker rule a resolution authority problem. The problem many analysts have with resolution authority is that it’s not credible to wind down massively interconnected banks with global reach. But if swaps desks must be walled off from the mega-banks, and if they cannot engage in proprietary trading, suddenly they become less interconnected, and it will become easier to unwind them should they find trouble.

What’s important to understand here is that the House and Senate bills have strengths and weaknesses in different areas. The House bill is stronger on resolution authority and continuing audits of the Fed, while the Senate bill is stronger on derivatives and consumer protection. Even within those categories, there are differences: the House bill retains a totally independent consumer protection agency, but the loopholes contained therein make it arguably worse than the housed-inside-the-Fed CFPA in the Senate bill. So it’s important to pick and choose among the bills to get the best mix. For example, the Miller-Moore amendment, which would allow the FDIC to give haircuts to secured creditors, and the Lynch amendment, which would limit the percentage of a swaps market any one dealer can hold, are really important amendments from the House side. Since we know that the Senate bill, by and large, will be the base bill for the conference committee, Konczal devises this correctly, highlighting the most important pieces to keep from the Senate bill first, while then adding in the good parts from the House bill.

I largely agree that these are the important elements. But nobody expects all of them to wind up in the final bill. In fact, many are already at risk, especially as it relates to derivatives. Huff Post Hill reports (it’s maddening to find a link for those newsletters, though they do exist) that the rumor which has been floating around for weeks, that the derivatives title may be supplanted with the language from the House bill, thereby eliminating Section 716 (which would force a spin-off of the lucrative swaps trading desks from the big banks). If Collin Peterson doesn’t succeed in this effort, you could see that grand bargain, where a stronger Volcker rule is added in exchange for redlining 716. Heather Booth of Americans For Financial Reform, the coalition leading much of this effort, rejects this grand bargain and actually threatens to withhold support.

“While we believe that (the Volcker rule and Section 716) are complimentary and good additions, they are not the same,” she said. Meanwhile, autodealers are working hard for their carveout in the consumer agency, and a broader effort is underway to prevent it from having an independent director — presumptively Elizabeth Warren? — and instead have a commission lead it. If these efforts are successful and the bill is weakened from its current position, said Booth, it may become unsupportable.

Emphasis mine. In addition to these concerns, I would add Konczal’s second section, Getting Our Banks Capitalized, as extremely important and under threat. Two amendments, one from Susan Collins in the Senate bill and the other from Jackie Speier in the House bill, would put hard capital requirements on the banking industry, in different ways. They fit together quite well, in that the Speier amendment offers a hard baseline of 15:1, while Collins’ raises that level for larger banks and clearly defines “quality capital”. This is why bankers like Jamie Dimon can’t stand it.

The FDIC likes the Collins amendment. If there is more capital and less leverage at the holding company level, it can be used to fund subsidiary banks before they fail and the FDIC funds are tapped to bail out depositors. That makes sense. FDIC Chairman Sheila Bair makes the point that the Source of Strength doctrine implies that holding company capital structures should be just as sound depository bank structures. The reasoning is not perfect, but it has a persuasive symmetry […]

Bank failure in the 40s was dramatized in “It’s a Wonderful Life.” Jimmy Stewart explained to his customers that the bank really did not have the money deposited by them. It went into loans to neighbors and friends and would be available when the loans were repaid. The scene depicted a run on a bank, a common phenomenon which plagued banks in times of crisis, until the FDIC came along to make the customers more secure […]

Things have not changed so much. Bank runs by depositors have become a thing of the past because of the FDIC. The problem is not that the deposits are callable loans. It is that the derivative-embedded credit between banks and industrial companies are actually complexes of callable loans. Bank customers withdraw deposited funds when they become insecure. With trading, counterparties demand collateralization of all out-of-the-money risk when insecurity sets in. That’s what happened to Lehman and AIG, and Enron before them, as well as some lesser known institutions.

A bank run now happens at the trading level. Chairman Bair was right. Depository banks need to be protected from the holding companies.

Basically, all four of Konczal’s key areas are under attack from the finance lobby. All four are crucial to get us closer to a safe and working banking system. Negotiations continue throughout the weekend.

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David Dayen

David Dayen