How Financial Reform Gets Done (Not)

How Financial Reform Gets Done (Not)

Today provided yet another example of how the best government money can buy works. The Senate majority leader Harry Reid suffered an embarrassing defeat when his effort to pass a motion for cloture, which would have stopped debate on the financial reform bill, failed due to two Democrat and one Republican defection among the votes he thought he had. And the naysayers are the typical "teki no teki wa mikata" (enemy of enemy is friend) alliances that are routine in politics. The Republicans are virtually united against the bill (the only defections are the two senators from Maine); the two rogue Democrats, Maria Cantwell (Washington) and Russ Feingold (Wisconsin) are opposed because the feel the bill is not tough enough (Cantwell wants votes on two amendments).

This tempest in a teapot is engaging distraction. Why have political commentators been hesitant to connect the dots between the "no incumbent left standing" movement and the lack of meaningful financial reform?

Despite an impressive amount of scrambling to get tougher amendments added at the last minute to the Senate bill (which before we get too excited, still has to be reconciled with the House version), most of the proposals either amounted to much less than their headline billing suggested. or conversely, were ineptly conceived, with the result that the the industry howling that they would be monstrously disruptive was actually correct, which allows the banks to gut or block those measures.

David Dayen at FireDogLake (hat tip Richard Smith) has some is a welcome exception:

It's not that voters had any knowledge of this when they went to the polls yesterday. It's that they've seen shenanigans like this consistently for the last five years. They've seen it on the Military Commissions Act and the Iraq funding bill in 2006, the FISA bills in 2007 and 2008, TARP in 2008, the health care bill in 2009, and now FinReg in 2010. They've seen defeat grabbed from the jaws of victory over and over and over again, and they simply have lost all trust in this crop of elites to do the job. And it's hard to argue with the public on this one.

This piece of his post caught my eye:

All through this time, Chris Dodd filed an amendment to gut the strongest piece of his own bill – the derivatives piece "authored" by Blanche Lincoln. I say "authored" because it was completely obvious that she was handed this tough bill for the benefit of her re-election, and even though that wasn't secured last night, on the very same night they submitted the weakening piece in the form of a manager's amendment. Instead of spinning off the lucrative swaps trading desks from the big banks, the bill as amended would let the systemic risk council, made up of agencies who opposed the proposal, "study" the provision, until making a (foregone) decision in two years. Lincoln says she'll fight against the weakening amendment – oh, we'll see about that.

Yves here. If the derivatives language was indeed provided to Lincoln as a bit of useful pre-election theater, the process is every bit as cynical as I thought. Readers no doubt know I am no fan of big financial firm chicanery, and a card carrying hater of credit default swaps (for background, see here). But the Lincoln amendment is guaranteed not to happen. The industry is correct in howling that implementing it would be hugely disruptive (the dealers themselves are the biggest users of plain vanilla interest rate and FX swaps; their trading volumes would overwhelm any independent swaps dealer). Banking industry expert Josh Rosner noted by e-mail,

[The amendment] would move bank derivative activities into a new shadow system where end users begin to build insufficiently regulated dealer businesses (which the banks/i-banks would buy an unconsolidated interest in).

Yves again. So the amendment (supposedly) creates a huge flurry of initial press about how tough she and the Dems are to those nasty banks, but then gets quietly excised or watered down to irrelevance when no one is looking. And by mid-term elections, the assumption is no one in the chump public will understand what the bill does or doesn't do. The key element is that the Dems can say they have a banking reform notch in their belts as a talking point.

Another headfake is Volcker Rule (which would require banks that can access emergency facilities like the deposit window to exit proprietary trading) as now embodied in the Merkley-Levin amendment. Economic of Contempt and your humble blogger seldom see eye to eye, but he is 100% correct on this one:

The biggest problem with Merkley-Levin is that its authors appear to confuse "definitions with more words" with "more specific definitions" (and thus less of that evil regulatory discretion). Merkley-Levin prohibits "proprietary trading," which it defines very broadly, and then creates 9 categories of "permitted activities" (listed in section (d)(1) of the amendment). The categories of "permitted activities," which function like exceptions to the definition of "proprietary trading," are so ridiculously broad that they completely swallow the amendment's prop trading ban.

Yves again. He shreds it in lurid detail. Yet Merkley is either a great actor or is completely unaware that he has been played for a fool (see 1:45-2:05 on this clip).



Not that it matters, his amendment was one of the two that was to be sidelined by the cloture vote today. I don't understand this tactically; letting empty "reforms" go forward would seem to be a win/win. But the Republicans seem to be sticking to the "all regulation is an expansion of government and therefore bad for Main Street" script.

Some otherwise astute commentators appear to have fallen for the industry's posturing. It has taken the position that it is non-negotiable and complain vigorously over every possible change that might be foisted on it, no matter how minor. That allows it to (later, with convincing-sounding squeals of pain) give ground on issues that are not a big deal or it can compensate for with little inconvenience.

For instance, one apparent win in the Senate bill was the insertion of a provision allowing the powers that be to oversee debit card fees to merchants (personally, as I have discussed earlier, I see debit cards as a bad product for consumers, since they serve much the same function as an ATM card with vastly less security). But credit card networks had sorta forced merchants to take debit cards (they were effectively co-sold with the credit card merchant accounts, and since credit card customers spend more per transaction than the norm, it was in a vendor's interest to accept credit cards), expect them to reverse their model, doing more to steer merchants and customers back to credit cards (their old model) and improving the profitability of the credit card product by cutting or eliminating frequent flier miles. So while this indeed is a win for merchants, it's quite another matter to think this is going to make a lasting dent in the returns the industry makes form the debit/credit cards payment complex. As the credit card reform initiative has shown, the banks have proven to be masters at finding new ways to extract income when the old mechanisms are blocked (and remember, that assumes this measure survives reconciliation with the House bill).

One exception that has oddly gotten virtually no press (perhaps a sign it is destined to die a quiet death in due course) is an amendment added to the Senate bill last week by Susan Collins of Maine, which would require banks with more than $250 billion in assets to have higher capital ratios, and would disallow inclusion of trust preferred securities in Tier 1 capital (hat tip John Bougearel). Shiela Bair supports the measure and Geither opposes it, which is revealing since the Treasury Department has said it is in favor of measures to make it more costly for mega banks to be mega banks as a way to force them to streamline…and the main measure was to be via higher capital charges for really big players.

The Geithner position, as Richard Smith discussed last week, is now to defer to Basel III, the new international bank capital standards which are currently under development, which conveniently could not possibly go live before 2016. The argument is on one level sensible, that the US needs to adopt standards that are reasonably consistent with those implemented abroad. However, on another level, it assures a race to the bottom if industry enablers masquerading as regulators use "harmonisation" as an excuse to do as little as possible. Since Europeans are very attached to their "universal banking" model, don't expect Basel III to impose much in the way of extra demands on really big banks.

So despite the theatrics in Washington, I recommend lowering your expectations greatly for the result of financial reform efforts. There have been a few wins (for instance, the partial success of the Audit the Fed push), but other measures have for the most part been announced with fanfare and later blunted or excised. Even though the firestorm of Goldman-related press stiffened the spines of some Senators and produced a late-in-process flurry of amendments, don't let a blip distract you from the trend line, that as the legislative process proceeds apace, the banks will be able to achieve an outcome that leaves their dubious business models and most important, the rich pay to industry incumbents, largely intact.

More on this topic (What's this?) The Second Leg of the Great Depression Was Caused by European Defaults
http://www.philstockworld.com/2010/05/11/the-second-leg-of-the-great-depression-was-caused-by-european-defaults/

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