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A Stilleto in the Back of Financial Reform

On Tuesday, the House Financial Services Committee voted out six bills that would make changes to the Dodd-Frank financial reform law that could have far-reaching consequences. The bank lobbyists deserve a bonus this year. On second thought, the hundreds of millions of dollars paid by Wall Street to K Street suggests that success in the face of prudence and good public policy is in the basic job description.

Despite a letter opposing the package from Treasury Secretary Lew, 22 to 24 of the 28 Democrats on the Committee voted for the various amendments. The fact that they ignored Jack Lew at least salves my bruised self-image. I was the sole progressive witness at the hearing on these bills and clearly was not sufficiently persuasive. On the other hand, I was not asked a single question about the legislation by the Committee. At least we have a bicameral Congress and Senate rules make enactment difficult.

Particularly troubling are the public statements made by Democratic members that were sponsors of particular bills. These statements make one wonder, do they not know what they are talking about or do they just not care.

One of the bills eviscerates the Dodd-Frank rule requiring that many risky derivatives be transacted by banks in subsidiaries that do not benefit from FDIC deposit insurance, among other forms of government support. Representative Jim Himes (CT) reasoned that FDIC insurance is funded by fees on the industry so public money is not really at risk.

The Congressman, a former Goldman banker, is using some shaky financial analysis here. The real point is that FDIC insurance of deposits entangles the government in any bank failure, increasing the probability that extraordinary measures to bail out the bank will be needed. The American people put trillions of dollars on the line to protect the big Wall Street banks from their own failure without ever paying out on FDIC insurance to their depositors. And the eviscerated section of Dodd-Frank prohibits Fed bailouts through targeted credit facilities and the discount window as well as FDIC insurance of banks trading risky derivatives.

There was also bipartisan support of bills that would allow the banks to move their trading beyond the jurisdiction of US regulators, even though the risks inevitably come home to roost at great cost to the US economy. The London Whale debacle happened in London, but it was JP Morgan Chase that lost 25% of its share value as a result. And remember that the AIG swaps were transacted in London also, but it was the US financial system that was devastated. The rest of the world got caught in the downdraft.

Representative Gwen Moore, a sponsor, reasoned, “The notion that now we should just do nothing and continue to cripple the economy is something that I reject." This is baffling. The economy is served well by a financial system that is safe and sound and is not fixated on parasitic activities that transfer money from job-creating productive investment to Wall Street bonus pools.

Even the European Union and the UK, whose interests align best with ours, are wobbly on bringing discipline to the financial markets. With banks weakened by their ongoing troubles, the Europeans are particularly susceptible to warnings against loss of bank profitability. And the UK economy is deeply dependent on the City of London. The US regulators should be supported in their negotiation of cross-border regulation, not undercut by Congress.

The truth is that the regulators, or at least the CFTC are valiantly and meticulously addressing all of the issues that are the subjects of these bills. CFTC Chairman Gary Gensler, also a Goldman alum and one that is putting his experience to good use, is pursuing a sensible course designed to protect the American public.

Even if these bills do not find their way into law, they serve a useful purpose for the financial sector lobby. They would be a shot across the bow of the regulators whose budgets would be starved of funding if the House of Representatives had their way.

Chairman Gensler is fighting on, doing his best to balance the threat to his agency against sensible rulemaking. The SEC, it must be said, is not putting up equally valiant resistance.

The conundrum is that there are signs that financial sector regulation has increasing, bipartisan support at some levels. After all, the Senate bill that would more aggressively address too-big-to fail banks is known as Brown-Vitter.

But the financial lobby understands that sometimes a stiletto is just as effective as an axe. These House bills are not benign technical adjustments. They create loopholes that could vastly alter the outcome of reforms to the financial markets that protect us from catastrophic system failures and parasitic trading excesses. They must be seen for what they are, not camouflaged by industry talking points delivered by policy makers.