Seven questions for seven bills (or, derivatives for dummies)
This month, a House subcommittee and possibly the entire House will consider a passel of bills to repeal several reforms that Congress approved in the 2010 Dodd-Frank Wall Street Reform Act.
Sponsors will parade the bills as technical corrections, non-controversial, or important for the economy.
Untrue, untrue, and untrue.
Here are brief summaries of these bills along with questions that members who are wary of their true impact might raise in committee hearings or during floor debate.
HR 634: The Business Risk Mitigation and Price Stabilization Act
This bill would forbid Wall Street banks from requiring “margin” for swaps if their gambling partner is a small business or bank. Margin here plays the same role as good faith money. If you bet a banker $100 that the Washington Nationals will beat the San Francisco Giants, he’ll want to see at least $10 on the table to make this bet real. And if the score is 10-0 Giants in the eighth inning, he’ll want to see another, say, $50 on the table in “variation” margin. Requiring no margin might be acceptable for smaller bets. But what about a $1,000 bet? Some limits may be required. That’s prudent banking.
Wall Street argues that requiring margin would squander Main Street capital that could be better used elsewhere. Main Street can benefit from derivatives as hedges, such as locking in a price for fuel. But hedges cost money. Banks can only engage in swaps because the national bank regulator interpreted them as the functional equivalent of a loan. No prudently managed bank could or should offer a loan or a hedge “for free.” In fact, as MIT Professor John Parsons explains, no bank does. Those swaps without explicit margins cost more in price—like a mortgage without points, but at a higher interest rate.
A question for this bill’s backers: If requiring margin from Main Street clients for swaps contracts ties up capital, should banks be prevented from charging periodic interest on commercial loans, and instead simply ask for repayment with interest at the end?
HR 677: Inter-Affiliate Swap Clarification Act
Mega-banks such as JP Morgan have thousands of subsidiaries, and they engage in swaps between these subsidiaries. Why? One reason is to teleport the swap outside the United States and escape U.S. government oversight. The regulators already exempt many inter-affiliate swaps from many prudential requirements if such transactions truly amount to moving socks from one drawer to another. But Wall Street wants regulators forbidden from checking to see if there may be, say, the metaphorical equivalent of tawdry magazines beneath those socks in the other drawer.
Question: Since swaps represent risk, is it appropriate to forbid prudential regulators from proposing appropriate rules to mitigate the risk?
HR 992: Swaps Regulatory Improvement Act
Financial institutions get a better deal on swaps if they use the taxpayer-backed, FDIC-insured bank in the bet/transaction, as opposed to another affiliate. For example, Bank of America Corp. subsidiary Merrill Lynch shifted trillions in swap dollars to Bank of America National Bank. Those betting against Merrill Lynch felt better knowing the taxpayer would make good on these bets.
But Congress declared in Section 716 that swaps must be “pushed” out of the bank. HR 992 lets banks keep swap dealing in the bank.
Question: Why should taxpayers effectively subsidize swaps?
HR 1003: (Unnamed) Cost Benefit Analysis
Unhappy with Dodd-Frank, Wall Street regularly sues regulators to block implementation over new rules. A judge ruled in favor of Wall Street in one case, and cited faulty cost benefit analysis. Since then, Wall Street has decided that cost benefit analysis is more important than national defense. HR 1003 would establish new, nebulous hurdles for the regulators to surmount, including proof that each option is “the least possible burden on society.”
Question: Since the financial crash cost the economy more than $12 trillion, should all cost benefit analyses list this figure as the benefit of all new safety rules? And if no one rule yields such a benefit, what if we divide by 400, which is the number of rules from Dodd-Frank, so that the benefit on average of each rule is, roughly, $30 billion. (That’s the state budget for Maryland.)
HR 1256: The Swap Jurisdiction Certainty Act
Many of the most dangerous swaps activity leading to the 2008 crash officially involved the Cayman Islands, London or other foreign jurisdictions. The biggest U.S. taxpayer bailout covered AIG’s London-based bets on credit default swaps (CDS) of $165 billion. (In real dollars, that was about half the cost of World War I.) Dodd-Frank repaired this by authorizing oversight by American regulators of these activities, no matter the domicile. HR 1256 eliminates that reform and allows the foreign regulator to oversee the American firm operating in the relevant domicile. As one senior regulator said to me in private conversation, this bill “bazookas a hole through the bottom of the boat.” It allows U.S. firms to effectively choose their referee, by conducting in swaps activity in a jurisdiction with the most lenient overseers.
Question: What incentive do foreign regulators have to ensure scrupulous compliance by American firms with their prudential laws? If JP Morgan London loses another $6 billion on a swaps bet – as it did last spring — will British taxpayers be willing to bail out the American firm?
HR 1341: Financial Competitive Act
Many Wall Street firms made bets without the capacity to make good on losses. See AIG, which was unable to cover its CDS bets. An international accord known as Basel III attempts to repair some of this problem. HR 1341 authorizes a study that will highlight the disadvantages to banks with a requirement that they can make good on these bets. Studies generally are good things. This one seems predicated on the thesis that the fight started when he hit me back.
Question: Would the author of the bill be willing to accept a friendly amendment that benefits be studied as well?
Bartlett Naylor is the financial policy reform advocate for Public Citizen’s Congress Watch division. Follow him on Twitter at @BartNaylor.
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