The deliberations of the Senate Finance Committee on health-care reform -- which, understandably, have monopolized the public's attention to Capitol Hill -- have concluded not a moment too soon. On Wednesday the House Financial Services Committee begins the first congressional mark-up of legislation every bit as important: the bills that would rein in Wall Street.
But there's a problem. Looking at perhaps the single most important bill the committee will consider -- the one that will regulate derivatives, those opaque contracts that brought down Bear Stearns and Lehman Brothers and would have brought down AIG but for $180 billion in taxpayer money -- the banks have nothing to complain about. The regulations don't amount to much. The peril these derivatives pose to the economy will persist.
Under current practice, these deals, whereby banks and corporations hedge against many kinds of risk, are unregulated. There is no place where these deals are reported, no open exchange on which companies can shop for the best deal available and on which prices and risk become transparent. There is no way to know when major financial players are holding trillions of dollars of paper that cannot be redeemed -- until they are about to go under, dragging the rest of the economy down with them.
The Obama administration has been trying to change all that. Led by Gary Gensler, the chairman of the Commodity Futures Trading Commission, the administration proposed a bill that would have established an exchange on which derivatives, like stocks and bonds, could be traded. "It's very important to have transparency," Gensler said Tuesday. "Without it, there's a very significant information gap" between the sellers and buyers of derivatives, and for regulators trying to gauge the level of systemic risk.
But the five biggest American banks make a lot of money from that information gap. Of the $291 trillion that is the notional value of all such deals held by American banks, fully 95 percent, according to the most recent report from the Office of the Controller of the Currency, was held by J.P. Morgan Chase, Bank of America, Goldman Sachs, Morgan Stanley and Citigroup. In the first six months of this year, those banks made more than $15 billion trading in derivatives. "A natural consequence of improving transparency and information on pricing [which happens on exchanges] is that the intermediaries who dominate the market will see lower profit margins and somewhat lower volumes of transactions," according to congressional testimony by Rob Johnson, director of the Economic Policy Initiative for the Roosevelt Institute.
Not surprisingly, those intermediaries -- the big banks -- have been fighting like mad to maintain their profits and our risk. So far, they're succeeding.
The bill that the House Financial Services Committee will take up Wednesday wouldn't establish an exchange. It would establish a clearinghouse, which is a weaker vehicle for tracking such deals. But it also would allow the banks and their counterparties to avoid posting such deals to the clearinghouse if they didn't want to, by insisting that their deal wasn't really standardized to clearinghouse practices. An earlier draft of the bill would even have exempted deals that hedged risk -- and since almost all such deals are created to hedge risk, it would have essentially exempted everyone.
Committee Chairman Barney Frank (D-Mass.) is none too thrilled by the watering-down he has been compelled to accept by the New Democrats -- chiefly Democrats from affluent, suburban swing districts -- on his committee. To his surprise, he said Tuesday, "there was no support for exchanges by community banks and end-users [the companies to which banks sell the derivatives]." Some companies said they feared that the increased margin banks would have to pay might be passed on to them in the form of higher fees. But it's the banks that the New Democrats, a number of their colleagues allege, are counting on for financial help in next year's tough reelection battles.
Fortunately, the legislation also has to pass the House Agriculture Committee, which is more likely to include a requirement that deals be conducted on an exchange, or at least that banks and companies report their deals to a clearinghouse. "As things stand now, I'd be more inclined to support the Ag bill," says Frank.
Notwithstanding the New Democrats, tougher regulations are not only good for the economy, they're good for the Democratic Party. If Democrats fail to rein in Wall Street's riskiest practices, says one unorthodox Democratic financier, "there's a real possibility that the Democrats will be answerable for Catastrophe Round Two. If the stock market pops again, placing major strains on banks that have been engaging in these very risky practices, the evidence trail this time will lead straight to the Democrats."