One of the smartest things I’ve heard in the Wall Street reform debate came from (predictably) Sen. Ted Kaufman, who said that financial regulations have a half-life. They only take so long before someone enterprising on the Street figures out how to circumvent them. The stronger they are, the longer that half-life – the Depression-era reforms managed to hold for over 50 years. So the goal must be for regulations that are as strong as possible, so nobody has to return to this arena for a while.
The Senate will wrap up their version of the bill this week, with Harry Reid possibly filing cloture today, setting up a motion to end debate on Wednesday (as I expected, there’s no way debate would end until Blanche Lincoln and Arlen Specter returned from the campaign trail). The bill has moved modestly in a progressive direction since it’s been on the floor. And some of those amendments actually may have a decent half-life (Paul Krugman’s cheerleading here – the bill ain’t that great). But one of the strongest pieces of the bill is coming under scrutiny because of what Americans for Financial Reform claims is a giant loophole:
Standard contracts and those not involving so-called “commercial end users” — firms like Coca-Cola and General Electric that use derivatives as insurance against currency and interest-rate fluctuations, for example — will be required to go through these clearinghouses.
The problem, however, is that there’s apparently little consequence if firms evade the requirements, according to the email sent to a Banking Committee staffer by Americans for Financial Reform, an umbrella organization of consumer advocacy, public affairs and union groups arguing for reform. Some of these potential loopholes were first identified by Zach Carter of AlterNet.
“[T]here is no consequence for counterparties who enter into uncleared swaps even after a finding by the [Commodity Futures Trading Commission] or [Securities and Exchange Commission] that the swaps must be cleared,” the email reads. The bill “does not prohibit the use of uncleared swaps and, even more egregious, expressly states that no swap can be voided for failure to clear.”
I’ve actually heard this twice about the derivatives bill, with the other complaint being that it wouldn’t spin off swaps trading desks into separate companies, but affiliates of the same company, leaving the corporate chief with the same lucrative portfolio.
The Senate Banking Committee claims that there are penalties for these activities, but once again, they appear to be at the discretion of the chief regulator, in this case the head of the Commodity Futures Trading Commission. Regardless of how intensely the current occupant will regulate (and Gary Gensler has actually expressed a desire to break up the market), future CTFC Administrators from future White Houses might find it easy not to offer a penalty for uncleared swaps. And that dramatically reduces the half-life.
On the other side of the spectrum, with one of the top amendments (which has yet to be voted on), the Merkley-Levin amendment to ban proprietary trading, the specificity of the requirements for regulators may be a problem:
Ideally, what the financial reform bill would do is just say, “Proprietary trades are banned; market-making trades are allowed,” and then let the regulators work out how to define “market-making trades” and “proprietary trades.” This is something that simply can’t be done at the statutory level; it has to be done at the regulatory level. Unfortunately, these days it’s fashionable for people to bash any sort of regulatory discretion as tantamount to letting Wall Street win. This is where Merkley-Levin comes in, because it’s clearly a response to this “anti-regulatory discretion” meme.
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.
I don’t know if you can categorize any or all of these pieces as impotent – I’ve heard this about almost every part of this bill. The complexity of the financial sphere gives credence to Kaufman’s analogy about half-lives; somebody on Wall Street is already testing how to get around these issues. What is required, and cannot be voted into law, is a set of regulators acting like regulators, providing the oversight and consequences necessary to hew to the spirit of the law, banning what needs to be banned, reflecting the intentions of the legislators. And recent history indicates that such regulators aren’t at a premium in America.