It's becoming an annual tradition: Spring rolls around, and while nobody is looking, Wall Street quietly lays siege to Washington and reaches a hand out to yank the last remaining teeth out of the government's financial regulatory head.
In the last two weeks, we've seen two major developments here. There was a wave of deregulatory bills that snuck through the House with surprisingly bipartisan support, and a series of regulatory decisions by the Commodity Futures Trading Commission that will seriously weaken the already-weak Dodd-Frank reform legislation, particularly with regard to derivatives trades.
If a story about a wave of bills designed to prevent the meager derivatives reforms passed in Dodd-Frank from being enacted sounds familiar, that's because it is. I wrote almost exactly the same story a year ago, in the middle of May, 2012, when a herd of Wall Street-friendly congresshumans teamed up in the House Financial Services Committee to push through a wave of nine ambitious bills targeting derivatives reform. This is from last spring:
The nine bills being contemplated by Congress take a variety of approaches to gutting Dodd-Frank. Two bills, H.R. 1840 and H.R. 2308, are essentially stalling tactics, requiring regulators to undertake more of those sweeping cost-benefit analyses that result in lengthy delays. Another bill, H.R. 3283, is more substantive: Sponsored by Connecticut Democrat and hedge-fund industry BFF Jim Himes, it exempts foreign affiliates of U.S. swaps dealers from all Dodd-Frank oversight.
The rule, if implemented, would make the next AIG possible, given that AIG was undone by half a trillion dollars in derivative bets produced by such a foreign affiliate – its London-based financial products outfit, AIGFP. If passed, says Rep. Brad Miller, a Democrat from North Carolina, H.R. 3283 would leave a "massive, gaping hole" in Dodd-Frank. "It would be very easy to move those trades to whatever the most indulgent country would be," Miller explains.
After those bills escaped the House, most of them stalled on the way to the Senate, where of course the Democrats still hold a majority and are reluctant to openly scrap Dodd-Frank just yet.
But this is the key to understanding how financial lobbyists succeed in getting what it wants on the regulatory front: They never stop. It's not a war of ideas, it's a war of resources. You march up the Hill with some crazy idea about overturning a bill prohibiting bailouts of companies that engage in risky derivative trades, you get knocked down, and you march up again, then you march up again, and again . . .
With each successive attempt, you peel off a few more Committee members in the House, slowly but surely weakening resolve. And while you're attacking on the legislative front, you also file a series of lawsuits that tie up the process by targeting reforms in court, and then you also send armies of lobbyists to sit in the laps of regulators during the rule-making process, so that key new laws (like the Volcker rule, designed to separate risky trading from federally-insured depository banking) are either written in reams of industry-friendly language, or delayed altogether.
No matter how bad your ideas are, and how unpopular they are (or, rather, would be, if anyone in the general public understood them and/or cared enough about them to complain to their congressional reps), you can still score huge wins just by continually attacking and chipping away.
Which brings us to this month: A little while back, I got a call from someone in the House. "You wouldn't believe the shit they just pushed through the Financial Services Committee,” he groaned. This person read off a list of bills, suggested I look them up, then specifically told me to look at how many Democrats voted "yea" on them.
"A lot of bad D votes on this one," was the editorial comment here.
Almost all of these bills turned out to be aimed directly at Title VII of the Dodd-Frank Act, i.e. the derivatives portion. They included:
H.R. 992 would "repeal most of Dodd-Frank Section 716" of the Dodd-Frank Act. This section, also known as the "Lincoln Rule," was one of the hottest of hot potatoes during the negotiations for the Dodd-Frank bill (see here for more details).
That portion of Dodd-Frank began with a simple, bold statement:
"Notwithstanding any other provision of law," it read, "no Federal assistance may be provided to any swaps entity with respect to any swap, security-based swap, or other activity of the swaps entity."
In other words, no matter what other laws are written, the federal government doesn't bail out any "swaps entities" or "activities of the swaps entities."
This sounds great, except Congress then decided on an exception or two to that law – among other things, federally-insured banks would be permitted to engage in swaps trading, so long as it was for "bona-fide hedging" and "risk-mitigation efforts."
Put another way, so long as the bank is merely guarding against loss, such behaviors are okay and bail-out-able.
But we've already seen that banks call pretty much anything hedging. In the case of the infamous London Whale trades – which were the very definition of stupid, reckless, doubling-and-tripling-down on insane billion-dollar bets high-stakes gambling – Chase and Jamie Dimon tried to call that activity hedging. Later, of course, in the Senate, Dimon was forced to admit that the trades, er, maybe were not hedging at all.
The lesson of this is that no law that allows "hedging" as an exemption will have much teeth, because most banks can find a way to call almost anything they do hedging.
But apparently this wasn't enough. This new bill in the House baldly expands the universe of trading activities that we may later have to bail out. It's actually written that way – check out this summary of H.R. 992, the "Swaps Regulatory Improvement Act" (God, I love the names):
Declares the prohibition against federal government bailouts of swaps entities inapplicable to: (1) a foreign banking organization supervised by the Federal Reserve; and (2) an insured depository institution or a U.S. uninsured branch or agency of a foreign bank that limits its swap and security-based swap activities to hedging and similar risk mitigating activities (as under current law), non-structured finance swap activities, and certain structured finance swap activities.
In English, this just means that in addition to hedging, which we banks think is pretty much everything we do, we'd like to be eligible for bailouts when we engage in "non-structured finance swap activities and certain structured finance swap activities."
If you read the fine print, what they mean by "certain structured finance swap activities" are swaps of a type and quality "to which the prudential regulators have jointly adopted rules," i.e. to be determined later during the rule-making process.
So to sum up, we banks would like to remain eligible for bailouts when we engage in hedging, which we think is everything we do, and also additionally when we engage in "certain structured finance swap activities," which will mean whatever we tell the rule-makers it means after the bill is passed.
This bill passed by a vote of 53-6 in the Financial Services Committee. Only six House members voted against expanding the types of financial behaviors that we may later have to bail out. Go figure.
Also passing in committee:
H.R. 1062, the "SEC Regulatory Accountability Act," is the same bill as H.R. 2308 from last year, requiring the SEC to undertake a cost-benefit analysis of any new rule before it is adopted. These "cost-benefit analysis" bills are pure stalling tactics. They have absolutely no purpose other than to force the government to spend valuable time, effort and money engaging in pointless reviews of rules that already in some cases take years to craft, incidentally with the constant input of bank lobbyists.
Politically, these bills serve another function. They allow members that may have voted for a certain reform originally to recoup some status with the banks by left-handedly undermining the rule later on with these pointless cost-benefit delays. This one passed 31-28 in committee.
Then there was H.R. 1256, the "Swap Jurisdiction Certainty Act," which:
. . . exempt[s] a non-U.S. person in compliance with the swaps regulatory requirements of a G20 member nation from U.S. swaps requirements unless the SEC and CFTC jointly determine that the regulatory requirements are not "broadly equivalent” to U.S. swaps requirements.
This is yet another leprechaun trick. What it basically means is that if you're Goldman or Chase and you have an office in some place like Mexico or Turkey or Russia or Saudi Arabia, you can do all the swaps business you want from there, undet whatever film of derivatives regulation exists in that country, without having to comply with U.S. swaps rules.
That is, unless the SEC and the CFTC make a joint determination that that country's laws are not "broadly equivalent" to our own.
This really just gives banks permission to go around the world regulator shopping. "It just makes it harder for the SEC to prevent regulatory arbitrage," is how one analyst put it to me. "That's all it does."
That one passed 48-11.
There are six more such bills, and who knows, the Senate might hold the line on all of them. But even if it does, nobody can stop regulators from backtracking on reform by writing crappy rules, which is also happening.
This past week, the CFTC released a series of new rules governing the swaps business. The rules are highly technical and basically unintelligible to people who don't work in these markets. But there are some basic concepts that can be understood.
To backtrack a little, the aim of reformers going into the Dodd-Frank debates was to do what FDR did with stocks after the crash of 1929: put them on open exchanges. That reform worked and has made the stock market a safe, thriving financial arena ever since. Today, when you go to buy a share of IBM stock, anyone can see what the price is, and there's constant data on bids and offers being that is made available to anyone who wants to participate.
But in the existing "over the counter" market for derivatives, the whole thing is a black box. There's no exchange where you can see with the price of this or that interest rate swap or credit default swap is.
"It's basically just a bunch of people on the telephone," is how Dennis Kelleher of Better Markets puts it. And when the five biggest banks control most of the derivatives market, the potential is there for all sorts of abuses.
The anemic Dodd-Frank bill halted well shy of forcing derivatives onto exchanges (coupled with the failure to break up the TBTF banks, it was the largest failure in the bill). Instead, it set up a structure of what are called "Swap Execution Facilities," or SEFs, which are a step somewhere between a completely opaque black box and an open exchange.
In the SEF model, participants can see some pricing data, but it's far from a system like the stock market, in which data from all trades is immediately and transparently posted. In fact, Wall Street has been fighting tooth and nail ever since Dodd-Frank passed to keep the activity in the SEFs as close to the old black-box model as possible.
There are two main avenues for preventing transparent swap trades. One is through something called an RFQ, or "request for quote," which allows participants in the market to pursue trading on an essentially private, person-to-person basis, without broadcasting the transaction to everyone. The other is through "block trades," which are trades so big that they can be done outside of the exchanges.
Without getting too far into the weeds, the new CFTC rules will significantly expand the use of both loopholes. "Wall Street and its allies fought to get as few RFQs as possible and to allow as many block trades as possible in the final rules," says Kelleher, adding that this was done to "prevent a level playing field, competition and transparency."
Essentially, the rules as written will keep the derivatives market functioning in pretty much identical fashion to the old "bunch of guys on the telephone" model. "It's pretty much the same system," sighs Kelleher.
Members of Congress, when they talk about having to vote on issues like derivative reform, express frustration about the political dynamics of this debate. When they go back to their districts, nobody is standing up at town halls and shaking fists about relaxing rules at Swap Execution Facilities.
On the other hand, when they return to Washington, they're inundated with bank lobbyists who offer extensive financial backing if they play ball on these votes, while simultaneously threatening to run primary candidates if they don't. Thus there are plenty of people in both parties who are extremely tempted to look the other way and accede to bank interests when it comes to the question of building the infrastructure for, say, the derivatives markets.
Moreover, the Democrats have become the victims of their own pusillanimity on these issues. The main Wall Street argument against these new rules is that they're excessive and onerously complicated. But they're only complicated because the Democrats didn't have the stones in the original Dodd-Frank debate to insist on simple concepts like putting all trades on open exchanges.
Instead, they built a system based upon a series of fiendishly complicated compromises. They keep adding more and more fine print to the infrastructural rules for things like Swap Execution Facilities and deriviatives clearing, and the more fine print there is, the more cracks and crevices Wall Street's lawyers can find to slither through.
Anyway, this is just a reminder that when it comes to getting transparency in the financial markets, this is what it takes. You have to fight the same fight over and over and over again. And again . . .