A House-Senate panel consolidating two versions of financial oversight reform is close to reaching a deal on prohibiting banks from risky proprietary trading, including the types of investment products or “derivatives” that fueled massive losses during the financial crisis of 2008.
But trading units have been quite profitable since then – especially for the largest financial institutions that have waged comebacks on the heels of mounting investment revenues. They include Bank of America, Goldman Sachs, Morgan Stanley and JPMorgan Chase.
The goal of reform is to separate trading desks from depository institutions holding many of the bank accounts of Americans. Those accounts are insured by an already-depleted government fund. Former Federal Reserve Chairman Paul Volcker, a top economic advisor to President Obama, has championed his “Volcker Rule” since January.
A variation on that rule was part of the House reform bill approved in November. Senators Jeff Merkley, D-Oregon; and Carl Levin, D-Michigan, introduced their own Volcker-like proposal that bars banks, bank holding companies, and their affiliates and subsidiaries from “high risk speculation involving any stock, bond, option, commodity, derivative, or other security or financial instrument.”
It also bars those entities from investing in or sponsoring a hedge fund or private equity fund.
An a more controversial proposal from Sen. Blanche Lincoln, D-Arkansas, is reportedly being modified to give institutions two years to spin off their swaps trading desks into subsidiaries. Federal regulators would determine the impact of the measure on the banks’ mortgage and small-business lending operations, and its effect on jobs and bank capital requirements.
Under the modified law, banks carrying deposit account insurance would be allowed to operate a swap-dealing desk within a separately capitalized affiliate.
The revised swaps spin-off proposal is intended to address concerns of regulators, including Sheila Bair, chairman of the Federal Deposit Insurance Corp. Bair and others say they are concerned that banks would be unable to hedge risks in interest rate and currency products, a primary function of many derivatives strategies.
Revisions may allow banks to hedge with swaps as market participants, but not allowed to operate a trading desk.
The mostly unregulated over-the-counter derivatives market generated $24 billion in revenues in 2009, with an estimated 98 percent of that total going to JPMorgan, Bank of America, Goldman Sachs, Morgan Stanley and Citigroup, according to Reuters.
Rep. Barney Frank, D-Massachusetts, who is chairman of the House-Senate conference committee, has said he would like to have the bill ready for President Obama to sign by July 4th.
