Tucked into the new federal spending bill that passed this week was a provision to loosen banking regulations on hedges known as derivatives or swaps, rolling back part of the Dodd-Frank Act that was enacted after the financial crisis. Dennis Kelleher of Better Markets and Mark Calabria of the Cato Institute join Hari Sreenivasan for a discussion on what the bill means for banks.
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Next, let's turn to a story about Wall Street and banks that's angered many.
As one of its final acts last week, Congress passed a spending bill for 2015. Tucked into it was a provision to loosen banking regulations on hedges or bets known as derivatives or swaps. These are financial instruments that essentially allow banks to hedge bets on things that rise and fall in value, such as mortgages, currencies and interest rates.
After the financial crisis, the Dodd-Frank Act required big banks like J.P. Morgan to move some of those derivatives, or bets, to other banking units that don't have a federal backstop or guarantee from the government.
No federal guarantee means no bailout. But the provision passed last week essentially cancels it and says banks don't have to move those swaps around anymore.
Liberals were outraged. The most outspoken voice ahead of the Senate vote, Democrat Elizabeth Warren of Massachusetts.
SEN. ELIZABETH WARREN, (D) Massachusetts: Who do you work for, Wall Street or the American people? This fight isn't about conservatives or liberals; it's not about Democrats or Republicans. It's about money, and it's about power right here in Washington.
This legal change could trigger more taxpayer bailouts and could ultimately threaten our entire economy. But it will also make a lot of money for Wall Street banks.
But others, including Republicans and some Democrats, said that fear was overstated.
Senator Barbara Mikulski is a Democrat from Maryland.
SEN. BARBARA MIKULSKI, (D) Maryland: So, what did we do? We actually worked on a bipartisan basis. It took a little shove from some of us Democrats, but there both sides of the aisle want to look out for the little guy.
So, guess what? This legislation that has been so scrutinized needs to also take a look at the fact that it includes $1.5 billion so that the Security Exchange Commission can actually do its job.
For a closer look at the rollback and what it might mean for banks going forward, we get two views.
Dennis Kelleher is the president and CEO of Better Markets, a nonpartisan, nonprofit organization that promotes the public interest in financial markets. And Mark Calabria is director of financial regulation studies at the Cato Institute, a libertarian think tank. He's a former Republican staff member from the Senate.
So, Dennis Kelleher, let me start with you.
What does this allow the banks to do that they can't do now?
DENNIS KELLEHER, Better Markets:
Well, basically, what the banks do within their federally insured subsidiaries, which are backed not just by the government, by taxpayers, is they conduct their derivatives within that banking, that protected organization.
And what this law did is, it said, look it, if you want to gamble in the highest-risk type of derivatives, you have got to push them out of the banking-backed subsidiary and put them in a different subsidiary. You can gamble all you want, but you're going to gamble with your own money and you're going to get downside if you're going to get the upside.
You're not going to be able to stick the taxpayers with the bill. What happened in the budget bill is, it was a provision in an otherwise pretty good budget deal that said, no, no, no, the banks don't have to do that anymore.
And keep in mind there are almost 7,000 banks in the United States. This provision benefits about five, the biggest banks on Wall Street. Four of those banks do 93 percent of all the derivatives trading in the United States. So this wasn't a bank-friendly provision and it wasn't a provision that was friendly to taxpayers.
This was a gift to the biggest banks on Wall Street.
MARK CALABRIA, Cato Institute:
So, let me first say why I very deeply share Dennis' concern about bailouts, and I don't think we have ended too big to fail.
I think we do need to parse out some of the details. And, again, so let's think about — banks have an insured subsidiary, an insured part of the bank. And there's a bank that's uninsured explicitly.
It's important to keep in mind that what Dodd-Frank does say, however, is this uninsured part still has access to Federal Reserve support through its so-called 13(3) authorities. So, even if were these other part of the bank to get into trouble, they could still potentially be on the line for the taxpayer.
But, more importantly, let's keep in mind, Dodd-Frank already exempted the vast majority; 90-plus percent of derivatives are already allowed within the deposit part of the bank to begin with. So, with this change was said, we're going to treat all derivatives basically the same. You know, the credit default swaps, which are a credit event, are going to be treated like interest rates, will all be within the bank.
So, to me, I think the extent of this, both before the proponents and the opponents, have been a bit exaggerated, because the — again, I said 90-plus percent of derivatives were already exempted from this to begin with. And even those outside would have been potentially backed by the taxpayer.
And so let me close that with using the example the way AIG was set up, and AIG had a bank subsidiary. AIG had all of its credit default swap business outside of its insured depository. Yet we still bailed out AIG.
So, I'm left wondering what this change would have stopped in that case.
Well, sometimes facts obscure, rather than clarify.
So, Mark's right that this provision applied to less than 10 percent of the derivatives tradings of these four biggest banks. But what that doesn't address is, what is the most high-risk? So the 90 percent are interest rates, currency-type swaps, which are relatively low risk.
And, therefore, the likelihood of those types of derivatives causing the bank to fail and causing another crisis is pretty low. So the provision that was in the law was actually pretty narrowly targeted, focused on the highest-risk type of derivatives. That's what we wanted to push out of the banks, so taxpayers didn't get stuck with it.
And let's remember for a quite minute, Hari, in 2008, that was the worst financial crash since 1929. It caused the worst economy since the Great Depression. It's going to cost the United States alone between $15 trillion and $30 trillion, with a T., for the economic wreckage and the bailouts.
And what this provision, along with the rest of financial reform, is trying to do is to reduce the high-risk activities of this handful of too-big-to-fail banks on Wall Street, reduce those activities, or push them away, push them out, so that the taxpayer doesn't get the bill after the bankers get the bonuses.
So, why did some Democrats, as the one we heard, along with the president, go along with it?
Well, look, this was a $1.1 trillion-plus funding bill for the entire government.
And I think Senator Mikulski, the president, and many others on the Hill did a very good job of putting together a very good funding package. The problem, is like all bills — and I worked in the Senate for a long time — all bills are compromises. There are some things in there that you don't want and some things that you do.
And the president made the decision at the end of the day that there was more good than bad. As he said, and as Secretary Lew, the secretary of the Treasury, at an FSOC meeting today said, they didn't want the push-out provision in there, but they were stuck with it.
The important lesson there is, Wall — it's a light on how Wall Street gets its way in Washington. It doesn't have a bill that comes out with Democrats — Republicans and Democrats in the House and Senate have to raise their hand in the light of day to vote for Wall Street. They put them in these big bills, so that nobody has to vote for them, and they can get their special provisions. And the public's deceived and there's no accountability.
Mark, what about the central argument that he's making, is that we're essentially walking back down that road of banks that are too big to fail, that we're essentially going to protect these big four or five banks?
We are. And Dodd-Frank didn't end that. So, I mean, I'm not actually for piecemeal reform of Dodd-Frank. I would repeal the whole thing and start from the beginning, because I do think it didn't address the problems in the crisis.
Now, where — Dennis was quite correct in saying it's got to be the risk you're looking at. Where I would disagree is, to me, what happened is, we had a huge housing boom and bust that caused a recession. We lost two million jobs before September 2008.
We were in a recession by the time of the financial crisis. And so whenever I hear somebody say, oh, well, we don't want banks gambling with derivatives, I don't want banks gambling with shoddy mortgages, and we're going down that road again, low down payment, subprime mortgages. That's riskier than a derivative.
Banks lost billions on their Fannie-Freddie holdings of preferred shares. We didn't make them push that out. So, again, to me, I'm concerned that rather than say let's shrink the safety net, we get in these political arguments over, well, this constituency, that's bad because Wall Street likes it, but because the realtors and home builders like this, then that's OK.
And that's the debate we're in today, whereas, to me, we need to end all the bailouts.
All right. All right.
Mark Calabria, Dennis Kelleher, thanks so much.