Bloomberg reports that Senate Agriculture Committee Chairman Blanche Lincoln is expected to table a proposal to require commercial banks to separate their derivatives operations from their commercial banking activities. The intent is to prevent banks from using cheap deposits to subsidize risky derivatives businesses, and thus eliminate the government backstopping of these activities. This “no bailout provision” would also forbid banks to use emergency banking facilities like the discount window and FDIC emergency liquidity guarantees for their derivatives activities.
As appealing as this idea sounds, I’m skeptical as to whether it will solve the systemic risk posed by over-the-counter derivatives businesses, in particular credit default swaps (plain vanilla interest rate and foreign exchange swaps are much less problematic). On the one hand, ending the ability to use cheap deposit funding to support derivatives operations should raise the cost of providing these products and hence somewhat reduce the size of the market. On the other hand, securities firms like Goldman, Morgan Stanley, and Merrill Lynch, which did not enjoy deposit subsidies pre-crisis, were also participants in these businesses, which suggests that the impact of use of deposit funding on the economics of these businesses may not be as great as some would like to believe. Moreover, the Fed extended emergency support to non-banks deemed systemically important, namely the former investment banks plus AIG. Pretending that segregating derivatives operations means the government won’t run to their rescue in a crisis looks like wishful thinking.
But the bigger issue is that this proposal is likely to be watered down into meaninglessness by the industry. European banks like SocGen, Paribas, UBS, and DeutscheBank, are large derivatives players and have long operated as universal banks, meaning deposits can fund any and all balance sheet needs. Unless European regulators are prepared to adopt similar rules, the major US players are certain to howl that their competitive standing will suffer and they therefore need to have the same privileges as Eurobanks.
From Bloomberg (hat tip Tim C):
Lincoln’s bill is tougher than what Obama has proposed for derivatives oversight and could complicate efforts to pass a broader regulatory overhaul bill, lawmakers said yesterday. It would have to be approved by the Agriculture Committee and then incorporated into the broader regulatory-reform bill drafted by Senate Banking Committee Chairman Christopher Dodd. Dodd’s was approved by the banking panel last month on a 13-10 vote without Republican support…
Senator Judd Gregg, a New Hampshire Republican, expressed frustration that a deal between Lincoln and Senator Saxby Chambliss of Georgia, the Agriculture panel’s top Republican, had fallen apart under White House pressure. Gregg indicated the derivatives bill wouldn’t get Republican support…
The proposal, which would affect 25 to 30 banks that trade derivatives, is likely to generate strong opposition, analysts said. Along with Goldman Sachs and JPMorgan, the other three banks that control almost all swaps trading are Morgan Stanley, Citigroup Inc. and Bank of America Corp.
16 comments
Comments are closed.
Whether you do, or don’t segregate derivatives trading is a misdirection. What matters is if you execute a contract, can and will you perform.
Welcome back.
Again pure empiricism, which could lead to a bigger disaster. I wish so-called the “Office of Financial Research” were already operational.
http://www.securitiesindustry.com/issues/22_7/-25010-1.html
UH, not to be cynical here, but Lincoln’s Senate race opponent has set up a website:
http://www.bailoutblanche.com/
Mr. Halter has also used her campaign finance sources in attack ads–not a bad thing imo. (Leaving aside Big Ag which is bi-partisan sacrosanct in AR).
But if anything good comes out of what could be a mere political ploy, stranger things have happened.
yeah, “Blanche” as Obama calls her, is a total corporate shill. She’s a total blue dog democrat. She fought hard against health insurance reform because they were such large contributors to her campaign.
Sounds like a Rahm Emanuel game.
Leave the risk taking and the profits to
the smaller ‘small enough to fail’ banks
who have actual stakes in the game.
Once an bank becomes too big to fail, every
risk it takes is actually a risk taken by
the public. The only solution is
total oversight. The too big to fail
banks shouldn’t be able to buy a paperclip
without a regulator signing off on it.
Otherwise they just play roulette with
everyone else covering the bets.
“But the bigger issue is that this proposal is likely to be watered down into meaninglessness by the industry. European banks like SocGen, Paribas, UBS, and DeutscheBank, are large derivatives players and have long operated as universal banks, meaning deposits can fund any and all balance sheet needs. Unless European regulators are prepared to adopt similar rules, the major US players are certain to howl that their competitive standing will suffer and they therefore need to have the same privileges as Eurobanks.”
Basel 1 de-ja vu all over again.
Senator Lincoln’s proposal, along with mandatory clearing, will go further than other proposals. It is agreed currency derivatives and interest rate swaps are not the target, it is the credit default swaps. However, to rein in the credit default swaps distortion of financial market fundamentals,bankruptcy code distortions and rogue speculation, this additional step is necessary.
What is a shining star of Senator Lincoln’s proposal is the requirement that derivative dealers act as fiduciaries with their clients. When the derivative markets took off in the early eighties all derivative banks did act as fiduciaries with their clients and closely monitored their counter-party credit risk in their proprietary trading. The days of responsible proprietary trading are long gone. It is time for financial institutions to accept they have lost this “easy” source of revenue as a result of their own reckless behavior. The over-the-counter derivative markets are dead.
although I agree that this bill in and of itself won’t be enough, I also believe that there isn’t going to be one magic bullet.
we will likely need a bill like this AND other interventions to work in concert.
the “perfect” solution isn’t going to present itself. Thus, I think we need to find a few good solutions that will add up to very good.
To ALL:
Don’t be fooled by the cross current here. Just yesterday Sen. Gregg gave an interview to Bloomberg where he said what those of us who are working this issue inside the beltway know. A few weeks ago the WH decided to make this a political issue. They do NOT care about substantive reform. They only care about the fall elections.
Consider what happened yesterday…There was the White House meet on FSR. Mitch McConnell obviously felt he got played, went out to the lawn and delivered a blistering attack on the Dodd bill and the pending Blanche/AG language. Then Gibbs allowe Geithner to come down to the press room for the daily gaggle and deliver a rambling set of remarks. The message was clear. Anyone against the Dodd/Frank bill was un-American and in the pocket of greedy Wall Street.
Pelosi chimed in with her usual rhetoric along with Leader Hoyer.
Forget real reform, its out of the equation as today Harry Reid announced “enough is enough” and now plans to bring the bill to the floor a week earlier than anticipated.
What remains to be seen is whether Senate Reps can muster the votes on key issues. One thing for sure, the WH blew this deal up, not Dodd, not Blanche. Team Obama did this and its a terrible way to reform the securities industry.
It was McConnell doing the playing. He had just finished visiting Wall Street Bankers. Did you understand that are you just whining like a little bitch?
There is not much you can say to that as long as you don’t have information on what she does propose to be the meaning of segregating.
It is as the Dodd bill, quite elusive as a topic of discussion because not many people have actually seen the text of it.
The verb “to table” can mean either “to present for consideration” or “to withdraw from consideration”.
In my dictionary, the first definition I listed (and the one you used) is marked as chiefly British.
I would recommend you avoid using that word in favor of clearer language.
Not too sure how I found this blog but glad I did find it. Think I was looking for something else on yahoo . Not sure I agree 100% with what you say, hopefully you will be adding to this site. Great website
I just installed an in-wall computer in my bathroom with a pull out keyboard tray and, with all do respect, this is the first blog I read while taking a number 2. This is getting bookmarked because it will always have a place in my heart, and bathroom. :-) Thanks for the great read.
I TOTALLY AGREE with Sen. Lincoln. Bankers should be on the conservative side and derivatives are definitely not conservative. Every Senator in Congress SHOULD SUPPORT HER VIEW.
LaVern Isely, Overtaxed Middle Class Taxpayer and Public Citizen Member