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Merkley, Levin, Brown Come Home to Dodd-Frank; Independent Experts See Problems

As expected, the major bank reformers in the Senate are generally praising the scraps they were able to institute into the Dodd-Frank bill (previously known as FinReg or Wall Street reform). Jeff Merkley (D-OR) and Carl Levin (D-MI), in a just-released statement, praised the inclusion of most of their Merkley-Levin amendment into the bill, while showing concern at the loophole written into it:

“The inclusion of a ban on proprietary trading is a victory. If implemented effectively, it will significantly reduce systemic risk to our financial system and protect American taxpayers and businesses from Wall Street’s risky bets. This is an important step forward from the current system that has placed few limits on speculative trading by either banks or other financial firms. Now banks will be prohibited from doing these trades and other financial giants will have to put aside the capital to back up their bets.

“Unfortunately, there is some danger to the principle posed by a loophole that allows for so-called ‘de minimis’ investing. While the overall Merkley-Levin framework is stronger than either the House or Senate bills, we will now be dependent on regulators to make sure that this exception does not weaken the rule.

“We are also pleased that the conference report includes strong language to prevent the obscene conflicts of interest revealed in the Permanent Subcommittee on Investigations hearing with Goldman Sachs. This is an important victory for fairness for investors such as pension funds and for the integrity of the financial system. As the Goldman Sachs investigation showed, business as usual on Wall Street has for too long allowed banks to create instruments which are based on junky assets, then sell them to clients, and bet against their own clients by betting on their failure. The measure approved by the conferees ends that type of conflict which Wall Street has engaged in.

The “de minimis” investing is bigger than the name implies. Basically, banks can use up to 3% of their Tier 1 capital to invest in private equity or hedge funds. Shahein Nasiripour’s roundup, which is the best I’ve seen, makes the crucial point – that this would represent large amounts of money over the original metric, which was tangible common equity:

Using JPMorgan Chase, the nation’s second-largest bank by assets with more than $2.1 trillion, as an example, the bank would be able to invest an additional 40 percent of its cash, or an extra $1.1 billion for a total of $4 billion, in the activities that Volcker wanted to prohibit banks from engaging in, according to the firm’s latest annual filing with the Securities and Exchange Commission.

For Bank of America, the nation’s largest bank with more than $2.3 trillion, that change allows the firm to invest more than $4.8 billion in hedge and private equity funds, an increase of 80 percent, according to the bank’s 2009 annual filing with the SEC. Morgan Stanley can invest $1.4 billion, a 58 percent increase, while Goldman Sachs can invest $1.9 billion, an increase of just 10 percent, securities filings show.

I don’t believe that banks put much more than that into hedge funds currently.

Shahein also intimates that some banks would be entirely exempt from this rule, including Massachusetts firms State Street Bank (which has $153 billion in assets) and BNY Mellon ($221 billion). Merkley-Levin may be somewhat more well-defined – and maybe not, it’s all still relative to a study by the regulators, so the prop trading ban could turn into basically nothing – and in the exchange, Scott Brown got a near-total victory.

Sherrod Brown (D-OH), whose Brown-Kaufman amendment would have limited bank size and capital, had a similarly praiseworthy announcement:

“This is an important step in our efforts to put Main Street ahead of powerful special interests. Passage of Wall Street reform legislation will provide American taxpayers with greater protection from the kind of risky Wall Street practices that put our economy on the verge of collapse and led to the loss of eight million jobs and six million homes.

“While I would have liked to impose tougher rules on derivatives and address the problems created by banks that are too big and have too much leverage, this legislation will help rein in the Wall Street banks and their financial weapons of mass destruction. We cannot allow short-sighted practices on Wall Street to put our economy on the brink of collapse.

“Wall Street banks risked Main Street jobs, Main Street pensions, and Main Street neighborhoods with get rich quick schemes that collapsed. Wall Street reform is the first step toward ending this.”

Do I argue with Brown? No legislation this big is either perfectly good or perfectly bad. You could cleave off some of this bill and come up with an amazing progressive victory, and cleave off another piece and find a shockingly evil corporatist nightmare. That sounds like an on-the-one-hand, on-the-other-hand sellout, but it’s really not. I’ve said consistently that this bill will not fundamentally change the way Wall Street does business, and that’s still true. I’ve offered praise for the parts that went through that will make a difference, like the interchange fees piece, or the consumer protection agency, or even the higher bank capital standards and requirements. I actually think it’s a great anti-mortgage fraud bill. Here’s the whole thing, in precis form. You can judge for yourself.

But it’s not a protection from a financial crisis. The regulators are modestly empowered, but they still have to do their jobs. The rules modestly limit bank profit and maybe even size, but they will have to be far tighter. There’s a process in place to prevent future bailouts, but it’s not at all credible that it can succeed. And most of all, even with these “landmark reforms” (when you do almost nothing for 70 years, anything looks like a landmark), it’s the political economy of the mega-banks, the influence and power of these major firms, which will have to be sharply reduced to create a sane economy,

Much work will have to be done to get us to that point. Even if you agree with the components of this bill, you understand that it only kicks off a process, an agenda for how to rein in the most destructive sector in our economy. You can run from that fight or engage in it.

One other thing: Barack Obama said he got 90% of what he wanted from this bill. Wrong. He got about 98%. He lost on the car dealer exemption for the consumer protection bureau. That was it. On the last day, the Treasury Department came in and negotiated the final details. The bill is called Dodd-Frank, and it could just as easily be Obama-Dodd-Frank. He can own it.

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David Dayen

David Dayen