U.S. lawmakers and their Wall Street supporters may have guaranteed another financial disaster like the one we're still recovering from.
Congress last week thought it was protecting the banks -- especially the six dominant players -- when it gutted the financial reform bill.
Investors thought so too. They bid up bank shares Friday. The Standard & Poor's 500 Financials Index jumped 2.8 percent. JPMorgan Chase & Co. rose 3.7 percent,
Goldman Sachs Group Inc. was up 3.5 percent.
Sorry, folks, you have it wrong. Congress was actually telling you to sell bank shares.
Ignoring evidence that investors were defrauded by subprime mortgage instruments that even bank bosses didn't understand, lawmakers are refusing to rein in the culprits.
Now we can be sure that soon we will be hoodwinked again by some cockamamie investment that's good for nothing but commanding commissions and promising trading profits for the banks. How about a package of exchange-traded funds, peppered with ones that use leverage and derivatives?
President Barack Obama said the bill's compromises give him 90 percent of his wish list for bank reform. The remaining 10 percent might be the killer.
Congress is caving in to pressure from the banks in two significant areas.
Wrist Slaps
Rather than forcing banks to spin off all derivatives trading as separate businesses -- preventing them from gambling with depositors' money -- Congress will let them keep trading the instruments if they are hedging their own risks or for interest rate and foreign exchange swaps.
They will have up to two years to move derivatives that can't be traded through a clearing house, including credit default swaps, into a separately capitalized subsidiary.
Lawmakers also watered down the Volcker rule, named after its proponent Paul Volcker, former chairman of the
Federal Reserve and an Obama adviser. Banks will be prohibited from trading for their own account. But Congress failed to ban them from investing in hedge funds, which bet on the investment fad of the day and charge huge fees, and leveraged-buyout funds, which load up on debt as if tomorrow never comes.
Mere Billions
The institutions will be allowed to invest as much as 3 percent of their so-called Tier 1 capital into such funds. That allows JPMorgan Chase, for instance, to invest $3.9 billion in these ways.
Wall Street didn't get its way entirely. The ban on proprietary trading should protect bank shareholders from a fair amount of nonsensical risk-taking with their money.
Banks will lose their advantage in setting prices on derivatives when the business goes to central markets where prices are set by all traders.
Still, the banks will basically continue to do business as before, focusing on trading instead of old-fashioned banking -- searching for huge profits and bigger bonuses. This can't be good news for investors or for the economy.
Citigroup Inc. will eventually put billions into whatever the successor to synthetic collateralized debt obligations turns out to be. Before that market collapses, its shares may climb from the current level of almost $4 back to their record high of $57 in 2006 and then sink to last year's low of about $1. Other bank stocks might trace the same path.
No Chance
Congress never considered real bank reform: Breaking up the Wall Street behemoths by separating commercial banking from riskier investment banking. Then if investors want to bet on Morgan Stanley making bets on credit default swaps, they can. The punters will always be with us.
It's unfortunate that the now publicly held investment banks can't revert to partnerships, with the partners at risk instead of the shareholders.
Commercial banks, including
Wells Fargo & Co. and
Bank of America Corp., then should be broken apart to increase competition for checking accounts, credit cards and home loans.
Wall Street at the moment has too much influence for this to happen. The banking industry's hulks will continue unrestrained. Their shareholders -- and no doubt the financial world at large -- will suffer again.
(David Pauly is a columnist for Bloomberg News. Opinions expressed are his.)
