12/18/2014 archive

Inside Wall Street’s new heist: How big banks exploited a broken Democratic caucus

David Dayen, Salon

Tuesday, Dec 16, 2014 02:45 PM EST

The so-called swaps push-out provision of Dodd-Frank, Section 716, forced commercial banks that trade certain risky types of derivatives to split them off into a separately capitalized subsidiary, uncovered by FDIC deposit insurance. Those attempting to downplay Section 716’s importance, like Paul Krugman, highlight the fact that uninsured institutions like Lehman Brothers played a critical role in the last crisis, and that risk can cascade through an interconnected financial system no matter where those risks are initially housed. This theory actually made it easier to get the rider through Congress, giving lawmakers a plausible story that the provision wasn’t central to reform.

But this overlooks how 716 didn’t just limit taxpayer bailouts, but removed a lucrative subsidy for the four major banks – Citigroup, JPMorgan Chase, Bank of America and Goldman Sachs – that control almost all of the derivatives market. By holding derivatives inside their depository units, these banks benefit from an implicit FDIC guarantee for its counter-parties should those units fail. Keeping them in separately capitalized entities costs the banks more in short-term borrowing. As the Wall Street Journal’s John Carney points out, the banks’ parent companies have lower credit ratings than the depository units, which affects the price banks can ask for derivatives.

So in the end, removing 716 just gives four banks a giant subsidy they would lose by splitting out the derivatives books, no different than the other CRomnibus riders that aid the bottom lines of wealthy benefactors. That has implications for safety as well – if risky derivatives are cheaper to fund and more profitable to trade, banks will increase their production. Furthermore, banks’ concerns about possible energy swap losses related to the crash in oil prices added a sense of urgency.

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The origins of eliminating Section 716 go back to the writing of Dodd-Frank itself. Blanche Lincoln, author of the derivatives regulations in the bill, initially included practically all swaps. A combination of lobbyists, Wall Street-friendly “New Democrats” and the Treasury Department significantly rolled that back, limiting it to the riskiest bits, like credit default swaps that don’t go through a clearinghouse.

After wounding the provision, the banks employed their allies in Congress to disappear it entirely. A bipartisan coalition, including Jim Himes, D-Conn., a former vice president at Goldman Sachs, introduced a host of bills to weaken derivatives rules as far back as 2011. HR 992, the “Swaps Regulatory Improvement Act,” sailed through the House Financial Services Committee 53-6 in spring 2013. The language of this bill, written by Citigroup lobbyists, is virtually identical to what passed in the CRomnibus. Rep. Maxine Waters, the ranking member on the Democratic side, waged a fairly lonely battle to limit Democratic support. On the House floor, 70 Democrats voted for the final bill, far fewer than was initially expected. This enabled Senate Democrats to ignore the bill as a stand-alone entity.

House Republicans, egged on by Wall Street lobbyists, tried another tactic. Kevin Yoder, R-Kan., a two-term member of the House Appropriations subcommittee overseeing financial services, stuck HR 992 into the financial services appropriations bill without a formal vote, pitching it as an aid to “the farmer in your district who wants to get a loan,” rather than Jamie Dimon or Lloyd Blankfein. Nobody ever tried to strip it out, and the rider easily advanced through the process.

Stuffing the rollback into a must-pass bill turned out to be a genius move. Lawmakers on the Appropriations committees have less understanding of complex bank maneuvers like derivatives than those on the banking committees. Furthermore, because all parties expected a year-end omnibus bill anyway, it didn’t make as much sense to fight every little provision, when a negotiated process would cover that down the road.

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Barbara Mikulski, D-Md., the outgoing chairwoman of the Senate Appropriations Committee, negotiated the CRomnibus with her House counterpart Hal Rogers, R-Ky. She ultimately signed off on the rider, in exchange for modest additional funding for the Commodity Futures Trading Commission and the Securities and Exchange Commission, two Wall Street regulators.

Bank reform groups and sympathetic lawmakers didn’t consider it a good trade to give a couple of regulators a bit more money in exchange for limiting what they can regulate.

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Senate leaders had to know that this swaps provision, for example, would cause plenty of consternation among colleagues like Elizabeth Warren, D-Mass. But they gave Mikulski all the space she needed to negotiate, and then pronounced themselves satisfied with the results. This stands in sharp contrast to Ron Wyden on the Senate Finance Committee, who watched Harry Reid go completely over his head in trying to negotiate a year-end tax deal.

Why did Mikulski get the hands-off treatment? For one, she’s earned respect as a longtime senator. Also, the leadership probably welcomed keeping their fingerprints off the final product, which was bound to be ugly. Establishment Democrats, including the White House, never really liked Section 716 to begin with, so they weren’t too displeased with watching it go, regardless of the blueprint it provided for repealing regulatory actions inside budget bills.

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(T)his shows real dysfunction in how Democrats work. Giving Mikulski carte blanche led to an embarrassing deal that revealed real fissures within the party caucus. The leadership should have seen this coming, but either let it happen or actively participated in the rollback (a claim from the Wall Street Journal editorial board that Chuck Schumer “engineered” the swaps provision had to be retracted within hours).

More important, the leadership failed to listen to the liberal wing, who were loudly and publicly opposed to the swaps rider. This is a familiar refrain from liberal congressional aides; their side of the argument never gets represented at the negotiating table.

The hardening conventional wisdom is that Wall Street lost more than it won with its power play on the CRomnibus, because it revealed itself as a giant liberal target. Mainstream Democrats definitely underestimated the strength liberal reformers brought to the fight, so maybe future actions will be undertaken with that in mind.

But it’s just as likely that the establishment didn’t mind the outcome, letting them look like the sensible centrists “getting something done.” That was probably the motivation behind President Obama ultimately endorsing and even whipping for the bill.

Whatever the outcome, we know that Wall Street exploited a fractured Democratic caucus to restore a big subsidy to its profits. And if Democrats don’t contend with that – or worse, if they don’t want to – you can expect many more congressional victories for the financial sector.

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New York Times Editorial Board: Gov. Cuomo Makes Sense on Fracking

Gov. Andrew Cuomo on Wednesday announced a statewide ban on the extraction of natural gas using a controversial drilling process called hydraulic fracturing. This was not an easy decision, but it was the right one. Many geologists and industry leaders believe that the deep shale formations underneath the state’s southern tier, known as the Marcellus Shale, contain bountiful supplies of natural gas. But extracting the gas, the governor concluded, carried – at least for now – unacceptable risks to the environment and human health.

In making what amounted to his first major decision since his re-election last month, Mr. Cuomo embraced the conclusion of state health officials that important health issues remain unresolved and that it was impossible to declare that hydraulic fracturing is safe for the environment or human health.

Robert Kennedy, Jr.: Coal, an Outlaw Enterprise

Last month, the coal industry in Appalachia suffered two legal blows.

On Nov. 13, federal prosecutors in West Virginia announced that Donald L. Blankenship, the notorious former chief executive of the Massey Energy Company, once Appalachia’s biggest coal producer, was charged with widespread safety violations and deceiving federal inspectors. [..]

Then, on Nov. 24, a Kentucky judge issued a scathing judgment against a Frasure Creek Mining settlement involving over a thousand Clean Water Act violations and years of false data on pollution-disclosure reports.

Coal is an outlaw enterprise. In nearly every stage of its production, many companies that profit from it routinely defy safety and environmental laws and standards designed to protect America’s public health, property and prosperity. In fact, Mr. Blankenship once conceded to me in a debate that mountaintop removal mining could probably not be conducted without committing violations. With a business model like that, one that essentially relies on defiance of the law, it is no wonder that some in the industry use their inordinate political and economic power to influence government officials and capture the regulating agencies.

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Today in History

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Cross posted from The Stars Hollow Gazette

This is your morning Open Thread. Pour your favorite beverage and review the past and comment on the future.

Find the past “On This Day in History” here.

December 18 is the 352nd day of the year (353rd in leap years) in the Gregorian calendar. There are 13 days remaining until the end of the year.

On this day in 1918, the House of Representatives passed the 18th Amendment to the Constitution, along with the Volstead Act, which defined “intoxicating liquors” excluding those used for religious purposes and sales throughout the U.S., established Prohibition in the United States. Its ratification was certified on January 16, 1919. It was repealed by the Twenty-first Amendment in 1933, the only instance of an amendment’s repeal. The Eighteenth Amendment was also unique in setting a time delay before it would take effect following ratification and in setting a time limit for its ratification by the states.

Section 1. After one year from the ratification of this article the manufacture, sale, or transportation of intoxicating liquors within, the importation thereof into, or the exportation thereof from the United States and all territory subject to the jurisdiction thereof for beverage purposes is hereby prohibited.

Section 2. The Congress and the several States shall have concurrent power to enforce this article by appropriate legislation.

Section 3. This article shall be inoperative unless it shall have been ratified as an amendment to the Constitution by the legislatures of the several States, as provided in the Constitution, within seven years from the date of the submission hereof to the States by the Congress.

The amendment and its enabling legislation did not ban the consumption of alcohol, but made it difficult to obtain it legally.

Following significant pressure on lawmakers from the temperance movement, the House of Representatives passed the amendment on December 18, 1917. It was certified as ratified on January 16, 1919, having been approved by 36 states. It went into effect one year after ratification, on January 17, 1920. Many state legislatures had already enacted statewide prohibition prior to the ratification of the Eighteenth Amendment.

When Congress submitted this amendment to the states for ratification, it was the first time a proposed amendment contained a provision setting a deadline for its ratification. The validity of that clause of the amendment was challenged and reached the Supreme Court, which upheld the constitutionality of such a deadline in Dillon v. Gloss (1921).

Because many Americans attempted to evade the restrictions of Prohibition, there was a considerable growth in violent and organized crime in the United States in response to public demand for illegal alcohol. The amendment was repealed by the Twenty-First Amendment on December 5, 1933. It remains the only constitutional amendment to be repealed in its entirety.

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Jason Bordoff

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