Tuesday, May 25, 2010

Financial bill falls short on big-banks issue

Business Times - 26 May 2010

Financial bill falls short on big-banks issue


AND they said it could not be done. Following months of debate, last week the US Senate in a 59-39 vote approved its version of the financial reform legislation.

The measure that supporters say could have dramatic effects on the way Wall Street operates was another major step towards Congressional passage of the most far-reaching revamping of the financial regulatory system since the dramatic overhaul in the aftermath of the Great Depression of the 1930s.

So it's done! (Well, almost).

The expectation on Capitol Hill is that the financial legislation could be signed by President Barack Obama before July 4. Mr Obama and the Democrats want to use the bill as an issue in the November midterm Congressional elections, by exploiting the populist sentiments among voters and painting themselves as the party that protects Main Street - as opposed to the Wall Street-type Republicans.

'Our goal is not to punish the banks, but to protect the larger economy and the American people from the kind of upheavals that we've seen in the past few years,' Mr Obama told reporters following the Senate vote.

The two Democrats who will be in charge of merging the separate House and Senate bills, Senator Chris Dodd and Congressman Barney Frank, sounded upbeat after meeting Mr Obama last week.

'I understand the urgency for the financial stability of the country in getting this done quickly,' said Mr Frank, the House Financial Services Committee chairman. 'It's hard for me to think that this is going to take us more than a month,' he suggested.

Indeed, analysts suggest that the financial crisis in the eurozone coupled with the investigations of Goldman Sachs' practices have put added pressure on the lawmakers to speed up the legislative process as well as to toughen up the bill.

'When this bill becomes law, the joyride on Wall Street will come to a screeching halt,' predicted Senate Majority Leader Harry Reid, a Democrat from Nevada, after the vote.

But will it? And is that a prospect that should be welcomed by investors and consumers? Or will it be back to business as usual on Wall Street sooner or later?

There is no doubt that the Wall Street bankers are very worried about the effects of the legislation, especially the restrictions on derivatives that could cut their profits. That explains why Wall Street's well-paid lobbyists are out in strength on Capitol Hill. They want to influence the drawing-up of the House-Senate reconciliation bill.

Add to the uncertainty about what the reform package would mean for their profits to the mounting debt crisis in Europe and the decision by Germany to ban certain types of financial speculation, and it becomes clear why there is so much anxiety in Wall Street these days.

Indeed, the perception among investors is that politicians in the United States and the European Union (EU) are responding to public pressure to crack down on the evil 'financial speculators'.

While Wall Street seems to be ready for such government action, the hope is that the US, the EU and other governments will work together to come up with a coordinated strategy on the issue, as opposed to discrete national legislation.

And the bankers warn that continuing uncertainty over the proposed legislation could force financial institutions to slow down the release of new credit to business and consumers and hold back economic recovery.

But if from the perspective of Wall Street the proposed financial reform measures are seen as too tough on their industry, critics of the big banks on Capitol Hill and elsewhere argue that the Senate draft does not force the too-big-to-fail banks to become smaller and is not tough enough on so-called proprietary trading. This is when big banks use their own money so as to make profits for themselves; in the process they turn into very large speculative funds.

While the Senate legislation did adopt the Volker Rule that would allow big banks to engage only in activities that directly benefit their clients and restrict their ability to invest in hedge funds and private equity, it assigned to government regulators the actual job of setting up these restrictions.

Supporters of the legislation have hailed one of its more creative ideas involving the US$600 trillion derivatives market. The Senate bill will make this market more transparent by having financial institutions trade these instruments on open exchanges and would have to clear them through 'central clearinghouses', forcing the institutions to put more collateral that would help to pay for potential losses.

In addition, an amendment to the Senate bill, introduced by Democratic Senator Blanche Lincoln from Arkansas, goes even further by saying that taxpayer-supported banks would not be allowed to trade and would have to create derivatives entities separate from their commercial banking operations.

But it says something about the power of the lobbyists for the banks that they are arguing that derivatives help banks control their risk - and they seem to be quite confident that this amendment will not be included in the final House-Senate legislation.

But the main criticism of the legislation is that it does very little to make those infamous too-big-to-fail banks, well, smaller.

The lawmakers rejected several ideas to break up the big banks and thus ensured the continuing concentration of financial power in the hands of five huge institutions whose future failure could produce another financial meltdown.

Copyright © 2010 Singapore Press Holdings Ltd. All rights reserved.

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