CommunityThe Bullpen

Swaps Trading Desk Spin-Off Intact

The Wall Street reform conference committee doesn’t meet today, as they wrapped up most of their work on the first week of the conference last night. Fawn Johnson at Dow Jones offers a wrap-up on the key issues, including the Collins amendment on capital requirements:

Lawmakers also are haggling over whether and how to grandfather all bank holding companies’ treatment of trust-preferred securities as Tier 1 capital, a key measure of a bank’s strength.

House members sought to tweak an amendment authored by Sen. Susan Collins (R., Maine) that would set size- and risk-based capital standards for financial institutions. Part of her package of new capital standards is a controversial rule that would bar bank holding companies from holding trust-preferred securities as Tier 1 capital.

Senate negotiators rejected that change, however, with Senate Banking Committee Chairman Christopher Dodd (D., Conn.) proposing that the measure grandfather trust-preferred securities only for institutions with less than $10 billion of assets.

Dodd said he discussed the House concerns, echoed by Senate Republicans, with Collins and that negotiators would work over the weekend in hopes of finding a compromise on the issue. Collins’s support is important because she is one of the few Republicans who voted for the bill on the floor of the Senate.

The Collins amendment looks like it will pass, with a delay. The grandfathering rule is important.

As expected, it doesn’t look as if the pre-funding of resolution authority will make it. But banks on the regional Federal Reserve bank boards will not be allowed to choose the regional bank President, which at least weakens the conflict of interest at the heart of the Fed banks.

Some big issues were held off to next week, including consumer protection and derivatives, which may be the final issue. It really looks like mega-banks will have to spin off their swaps desks into separately capitalized subsidiaries.

With final negotiations on the reform bill bogged down amid partisan bickering, Democrats who control the process neared consensus on an element that has drawn furious opposition from the Wall Street banks that could lose billions in profits.

The deal would require banks to isolate their swaps desks in separate affiliates, which would require the banks to raise new capital and deprive them of profits they get from dealing. But it would allow their parent holding companies to retain the value of the operations.

Barney Frank similarly said in an interview with Politico that the swaps measure would stay in place, saying that the technical issues were being ironed out, and that the clarifications already made move things closer to resolution. That’s a remarkable accomplishment. But it’s not the end of the story. In fact, as Zach Carter points out, we might want to focus on Section 608, not Section 716.

By eliminating taxpayer subsidies, Lincoln would force banks to raise more capital against their derivatives deals, which provides a cushion against losses, and prevents banks from overextending themselves on risky activities.

But for this plan to work, the bank—a company with access to taxpayer perks—can’t be able to simply bail out its derivatives affiliate when it gets into trouble. Those bailouts would ultimately be financed by taxpayer subsidies, rendering the whole point of the Lincoln plan meaningless. There are already laws on the book that limit transactions between banks and their affiliates (for wonks: Sections 23A and 23B of the Federal Reserve Act), but the laws are weak. Fortunately, Section 608 of the Wall Street overhaul that cleared the Senate significantly strengthens those rules.

Current law only keeps banks from bailing out their affiliates with traditional loans. If they want to use a more complicated transaction, like, say, a derivative, to salvage the affiliate, they can. The Senate bill tightens this language, barring banks from bailing out their affiliates with both securities lending and derivatives operations […]

Even more important, Section 608 requires affiliates to post collateral for any transaction they engage in with their bank. That means no free lunch for the derivatives affiliate if it gets into trouble. While banks can still make (limited) arrangements to save the derivatives affiliate, the affiliate has to put up something of equal value in exchange. In other words, the bank can’t just bailout the derivatives house with taxpayer subsidies.

Right. Given the way the maret will probably go – with the banks moving swaps into subsidiaries – there has to be a way to disconnect those two if something goes wrong, so taxpayer subsidies aren’t used to bail out the trading desk. Section 608 will get dealt with at the same time as 716, and it’s crucial that both move together.

Previous post

Nighttime Beach Cleanup Will Be Deadly for Sea Turtle Hatchlings

Next post

When There's Nothing On The Horizon, You've Got Nothing Left To Prove

David Dayen

David Dayen