After a year of posturing over regulatory reform by policymakers and bankers, both sides are taking off the gloves as Congress prepares for a decisive vote. And although the banks lost a few early battles, the odds are fair that the industry will emerge from the war with fewer scars than many expect.
The prospect of wide-ranging reform increased dramatically late last month when Republicans agreed to allow debate to proceed on a reform bill drafted by the chairman of the Senate Banking Committee, Christopher Dodd. The move came a day after CEO Lloyd Blankfein and other top executives of Goldman Sachs Group endured an 11-hour verbal bashing from a Senate committee over the firm’s marketing of a collateralized debt obligation that blew up in 2007.
That hearing produced no clear evidence or admission of wrongdoing, but by exposing a huge gap between Wall Street securities practices and Main Street’s sense of ethical behavior, it made legislation all but inevitable. As one senior industry executive put it privately, “This is not about Goldman being on trial — this is about the industry being on trial.”
The new climate was also evident when policymakers gathered in Washington late last month for meetings of the Group of 20, the International Monetary Fund and the World Bank. Mario Draghi, who is coordinating G-20 reform efforts as head of the Basel-based Financial Stability Board — and who is a former Goldman vice chairman — stressed the need for governments to implement regulatory changes. “The more we approach the end of our reform effort, the more the industry is trying to resist change,” he said. “This is understandable but should be resisted.”
To get Republican support, Dodd agreed to drop a proposal to tax the industry to create a $50 billion fund for shutting down failed firms. Banks had lobbied vigorously against the tax, which Republicans claimed would make future bailouts more likely. Many of the bill’s other provisions, including a resolution mechanism for winding down failed firms and the creation of a systemic risk council to monitor broader economic risks posed by markets, are expected to survive in close to their current form. Scott Talbott, senior vice president for government affairs at the Financial Services Roundtable, a lobby group, says the industry accepts the need for tighter regulation and can support 80 percent of the bill.
The main battles will be fought over derivatives and the so-called Volcker rule, which would bar banks from doing proprietary trading and investing in private equity or hedge funds. Wall Street supports the bill’s aim of bringing many over-the-counter derivatives onto exchanges and using central counterparties to reduce risk, but the question is how tight those requirements will be.
The stakes are huge. CEO Jamie Dimon told investors recently that new derivatives rules would cost JPMorgan Chase & Co. anywhere from a few hundred million dollars a year in revenues to as much as $3 billion, depending on how onerous they are. And that estimate didn’t cover a separate amendment by Senator Blanche Lincoln that would require banks to spin off their derivatives businesses, something the Obama administration hasn’t endorsed. Most observers believe that idea will be dropped because its impact would be so radical: “The capital markets would kind of stop,” says one banker.
Treasury Secretary Timothy Geithner predicted that U.S. legislation would galvanize international reform efforts. “We’re going to move,” he said. “I’m confident the world is going to move with us.”
Attention next will shift to the Basel Committee on Banking Supervision, which has proposed a raft of changes to raise capital and liquidity requirements on banks, including a measure that could force banks to triple the amount of capital supporting securities. Those rule changes will likely have as big an impact on the industry as any legislation coming out of Congress. Asked what his biggest regulatory concern was, one senior European banker said, “What will my core tier 1 be?”
Banks hope to have better luck influencing the Basel process through discreet and well-established contacts with regulators than they have had swaying lawmakers under the TV lights on Capitol Hill. More than 270 banks and industry groups filed comments on the proposed rules, with many citing fears that the changes would raise capital requirements too high and slow lending just when fragile economies need a boost. The FSB’s Draghi insisted that capital standards would go up only when the recovery was firmly established. “Ultimately we will have safer banks, a safer financial services industry, and possibly [one] not as profitable as it was in the past,” Draghi said.
After the turmoil of the past three years, that’s an outcome that policymakers and bankers would welcome.
