A successful all-nighter

A successful all-nighter

by The Economist online | NEW YORK

“MY OWN fear is that we’ve all died and this is our purgatory,” said Senator Chris Dodd recently, as negotiations between America’s House and Senate on reconciling their competing financial-reform bills—televised so that the public could share the pain—became bogged down yet again. Mercifully, the conferees eventually found a way out, albeit only after a marathon final session of haggling that lasted into the early hours of Friday June 25th and required a number of untidy compromises.

The deal all but guarantees Barack Obama his second big legislative victory this year, after health care. Both chambers are expected to approve the merged bill by the end of next week, though with a super-majority needed in the Senate, and most Republicans still opposed to the text, it could be close. If all goes well, the president will sign it into law by the July 4th holiday. But he will not wait until then to gain leverage from it: he had pushed for a deal by Friday so that he could present it as a model for other countries to follow at this weekend’s G20 meeting in Canada.

The bill is certainly sweeping in scope. It creates a new consumer-protection bureau, within the Federal Reserve, with powers to write rules for—and ban—financial products. It gives the government the power to break up any failing financial firm, not just banks, and pushes more of the clean-up costs onto surviving competitors, rather than the taxpayer. Those who securitise assets will have to retain more of the risk. Credit-rating agencies will be more exposed to legal challenge for their mistakes, and less able to cosy up to debt issuers. Under the so-called Volcker rule, banks will face limits on their proprietary trading and investment in hedge funds and private equity. Derivatives markets will no longer be left to do their own thing.

These last two areas proved the most contentious. The White House had intended the Volcker rule as a blanket ban, but it was forced to accept a watered-down version: banks will be allowed to invest a modest amount (up to 3% of their tier-1 capital) in hedge funds and private equity, though regulators will have less leeway than previously envisaged to waive the ban on prop trading. Included in the final version was the “Hotel California” provision, which would block bank holding companies from converting to investment-bank status to escape Volcker.

The compromise over derivatives was even messier. A proposal that would have forced banks to spin off their lucrative swaps-dealing units was taken up, but only for certain products. Banks can continue to trade foreign-exchange and interest-rate swaps as well as credit-default swaps that are run through clearing houses. But contracts deemed riskier (by some lawmakers at least), such as agricultural, energy, equity and uncleared credit-default contracts, will have to be handled by separately capitalised affiliates.

All this and a $19 billion tax
In all, the final bill is a bit tougher on Wall Street than was the White House’s original reform draft of a year ago—for that, thank a surge in anti-bank sentiment as the Senate took up debate. Nor were big banks thrilled to learn that the conference committee had, at the last minute, added a $19 billion one-off tax on them (and large hedge funds) to pay for the law. But they can live with the overall result, which is expected to cut their profits by anywhere between 5% and 20%, a sizeable but manageable portion. They are already busily looking for opportunities in emerging markets to offset the lost revenue. A management reshuffle this week at JPMorgan Chase reflected this shift of focus.

In any case, the rules are not yet set in stone. Much has been left for financial regulators to interpret. In a number of important areas, they have been given the job of writing more detailed rules after further study. So the door remains open for bank lobbyists, who will hope that, as in the past, their regulators prove more sympathetic than lawmakers. Further down the road, there is always the possibility of partial repeal: the Supreme Court is soon expected to rule on the constitutionality of the Public Company Accounting Oversight Board, which was created by the 2002 Sarbanes-Oxley act on corporate governance, and could well strike it down.

More is not always better
The Treasury was quick to tout the bill as the punchiest piece of banking law since the Depression. However, an age-old lesson in financial policy is that more regulation does not necessarily mean better regulation. The more rules banks face, the more they have to game. Only the most Panglossian would accept the Obama administration’s assertion that the bill signals an end to bail-outs of financial giants. It “is unlikely to achieve its own goal of preventing another crisis, but it is certain to produce an efflorescence of bureaucratic interventions, red tape and costs,” wrote Alex Pollock of the American Enterprise Institute, a think-tank, before the final version was agreed.

Furthermore, the measures that congressmen lost sleep haggling over may turn out to be less important in in guaranteeing future bank stability than those being discussed at the Basel Committee of international regulators. The Financial Times reported on Friday that banks had persuaded the committee to soften its proposals on the liquid funds that they will have to hold to see them through any future crisis. The G20 government leaders will discuss the committee's work at their summit.

Just as notable as what is in the bill is what is missing. There is no dramatic streamlining of the alphabet soup of regulatory agencies. Indeed, the new consumer bureau potentially creates another monster. Nor does it tackle the future status of Fannie Mae and Freddie Mac, to the chagrin of Republicans, who rightly view the two mammoth mortgage agencies as having played a leading role in causing the financial crisis. The final document may run close to 2,000 pages, but some very important issues are being left for another day.