Obama's Treasury Dept Working To Defeat Derivatives Proposal 'Of Utmost Importance' To Reforming Wall Street
A Senate proposal to force banks to shed their lucrative yet
risk-laden derivatives units -- which is vehemently opposed by Wall
Street -- is gaining steam, picking up the support of some regional
Federal Reserve chiefs with more on the way.
Yet President Barack Obama's Treasury Department, led by Timothy
Geithner, continues to oppose the measure, Senate aides say, who add
that Treasury is supporting Wall Street over Main Street by opposing
the measure considered of "utmost importance" to financial stability.
"It shows the access of the major Wall Street banks in the Treasury
Department in spades," one Senate aide said on the condition of
anonymity. Assistant Treasury Secretary for Financial Institutions
Michael S. Barr is said to be leading Treasury's efforts.
Senate aides say that more letters of support from other regional Fed presidents are on the way.
Treasury is joined in its opposition to the measure by the Federal
Reserve's Washington-based Board of Governors and the head of the
Federal Deposit Insurance Corporation, Sheila Bair.
Meanwhile, supporters include the longest-serving policy maker in
the Fed, Federal Reserve Bank of Kansas City President Thomas Hoenig,
Federal Reserve Bank of Dallas President Richard Fisher, Nobel
Prize-winning economist Joseph Stiglitz and House Speaker Nancy Pelosi.
Hoenig and Fisher wrote letters of support last week to Senate
Agriculture Committee Chairman Blanche Lincoln, the author of the
provision, referring to it as "of utmost importance to our nation's
long-term financial and economic stability."
"The dynamic with two Federal Reserve presidents coming out for it
publicly, and the fact that there are more who are probably going to
come out for it, means that [Treasury] can't resist it any longer," the
Senate aide said. "They're going to have to accept it, because [the
regional Fed support] is basically undermining both Bernanke as well as
Lincoln's proposal would compel the nation's megabanks to move their
swaps-dealing units, which deal and trade in a type of financial
derivative product, into a separately-capitalized institution within
the larger bank holding company. The affected firms collectively would
have to raise tens of billions of dollars to protect their swaps desks
in case their bets go bad. Or, they could disband the activity
Along with a few foreign banks, the nation's largest domestic banks
essentially control the swaps market in the U.S. By forcing them to
divest their units into separate affiliates, which in turn would compel
them to raise money to capitalize these affiliates, Lincoln's measure
could force them to scale down their operations. At the least,
supporters say, it would force them to have enough cash on hand in case
their bets begin to sour, saving taxpayers from having to step in to
prop up the banks like they did in 2008. That taxpayer support
In a report Monday, the Financial Times reported that
former Federal Reserve Chairman Paul Volcker softened his initial
opposition to Lincoln's measure, quoting him as saying: "I tend to
think of the bank holding company as the relevant organization."
Of the nearly 8,000 banks in the U.S., less than 25 would be seriously affected.
"It's really a Wall Street bank issue, not a community bank issue," the Senate aide said.
Treasury spokesman Andrew Williams insisted the agency has not taken a position on Lincoln's proposal.
The measure is supported by financial reform groups and academics
who wish to purge the riskiest of risky activities from the U.S.
banking system. Since banks enjoy taxpayer-financed protection via
federal deposit insurance and access to cheap funds from the Federal
Reserve, they shouldn't use that taxpayer support to subsidize risky
bets on derivatives, say proponents of the measure.
"Section 716 appropriately allows banks to hedge their own
portfolios with swaps or to offer them to customers in combination with
traditional banking products," Hoenig and Fisher wrote in separate
letters in reference to the part of the Senate's financial reform bill
that compels banks to split their swaps desks from the depository
"However, it prohibits them from being a swaps broker or dealer, or
conducting proprietary trading in derivatives. The risks related to
these latter activities are generally inconsistent with the funding
subsidy afforded institutions backed by a public safety net. Such
activities should be placed in a separate entity that does not have
access to government backstops. These entities should be required to
place their own funds at risk," the regional Fed chiefs said.
Senate aides say that Lincoln is clarifying the legislation in order
to allow for banks to appropriately hedge for interest rate risk, like
when banks offer consumers fixed-rate 30-year mortgages not knowing
whether interest rates are going to rise or fall over the life of the
loan; to have a phase-in period of up to 24 months so banks have time
to complete the transition in an orderly manner; to ensure that it's
clear that bank holding companies can house these swaps-dealing units
(some lawyers argue that the legislation is vague on this point); and
to ensure that banks can continue to offer swaps to customers in
conjunction with traditional bank products like loans.
"Banks that have been acting as banks will be able to continue doing
business as they always have," Lincoln said May 5 on the Senate floor.
"Community banks using swaps to hedge their interest rate risk on their
loan portfolio will continue to be able to do so. Most important, we
want them to do so.
In addition to Fisher and Hoenig, Lincoln cites support from the
Independent Community Bankers of America, the Consumer Federation of
America, the AARP, labor unions and leading economists.
"I think this shows that the [Fed's] Board of Governors and Treasury
are out of touch with how a lot of other people are thinking about this
stuff," said the Senate aide. "We're at the end of the game here, and
people are standing up and saying, 'You're not addressing the
underlying problem the way you ought to be.' It's tragic."
A spokesman for FDIC chief Bair declined to comment.
House Agriculture Committee Chairman Collin C. Peterson indicated
his support for the measure last week during House-Senate negotiations
over combining the chambers' separate versions of financial reform
Heather Booth, head of Americans for Financial Reform, a large
coalition of consumer and labor groups, said that she was told as of
Monday morning that some House conferees are still pushing to
substitute the lower chamber's derivatives language for Lincoln's
Senate language. Using the House language as the base would be a
setback to reform, said Booth, and the group is working hard to keep
bank-friendly Democrats from seizing the advantage.
"It is still an issue. We are concerned where the New Dems are on
that," said Booth, referring to the New Democrat Coalition, made up
largely of suburban Democrats with backing from the financial services
The Senate aide expressed confidence in Lincoln's measure withstanding challenges.
Reform groups are also pressing hard for a tougher version of the
Volcker Rule, which would prevent banks from trading with their own
money, unrelated to the benefit of their clients. The groups, along
with Senate aides, insist that it and Lincoln's derivatives rules are
complementary, not alternatives. Reformers are pushing for both to be
included in the final bill.
A White House spokesman said of Lincoln's spin-off measure that "we
continue to see this specific provision as only one small piece of the
sweeping derivatives reform that Senators Dodd and Lincoln and Chairman
Frank have championed. The Administration will not get ahead of the
work of the conference committee as members of the House and Senate
merge their respective bills. Our goal is to see a strong bill on the
President's desk by July 4th."
"At the end of the day, this might end up being what people will
refer to instead of Glass-Steagall, but Volcker-Lincoln," the Senate