‘Nervous’ Wall Street Waits for Congress to Kill Swaps Limit
Wall Street banks, surprised that the Senate’s financial overhaul passed with language that could curtail their derivatives trading, are now hoping the rule can be killed in Congressional negotiations.
Lawmakers have been telling Wall Street the Senate provision would fail, “but it passed, so people are nervous,” said Paul Miller, analyst at FBR Capital Markets in Arlington, Virginia. “The problem is that everybody in Congress wants it out, but nobody wants the responsibility of taking it out.”
The Senate bill demands that companies like Bank of America Corp., JPMorgan Chase & Co. (JPM), and Goldman Sachs Group Inc. (GS) conduct derivatives trading outside of their commercial banking units that benefit from federal support. They could still escape the impact if the rule is stripped out during a conference committee to resolve differences between the Senate bill and one passed by the House of Representatives in December.
“There’s a reasonable chance it will remain only because anti-bank sentiment has increased since the House bill was passed,” said Robert Litan, vice president of research and policy at the Kansas City-based Kauffman Foundation, which promotes entrepreneurial economic growth. While the likelihood is hard to handicap, he said, “it’s certainly not zero.”
Raj Date, a former Deutsche Bank managing director and now executive director of New York-based research group Cambridge Winter Center for Financial Institutions Policy, said he expects the rule to get watered down in conference.
“I think that gets eliminated and we end up closer to where the House is,” Date said. Otherwise, “It’s a sort of unmitigated negative for the biggest swaps dealers.”
The most likely compromise is that House and Senate members agree to conduct a study of the swaps provision, which may result in killing it eventually, said Brian Gardner, a former congressional staffer who is now senior vice president for Washington research at KBW Inc.
Derivatives are contracts whose value is derived from stocks, bonds, loans, currencies and commodities, or linked to specific events such as changes in interest rates or weather. They include credit-default swaps, which act like insurance for investors in case a debt issuer can’t repay.
Swaps sold by American International Group Inc. (AIG) that later went sour helped push the insurer to the brink of bankruptcy and triggered a $182 billion federal bailout of the New York-based company during the near-collapse of the financial system in 2008.
The new swaps rule was drafted by two-term Arkansas Democrat Blanche Lincoln, head of the Senate Agriculture Committee. Earlier this week Lincoln failed to win the Democratic primary and faces a June 8 runoff against Lieutenant Governor Bill Halter for her party’s nomination.
“The conventional wisdom has been that if she gets the nomination, she has the political room to drop the provision, but as long as she’s running for re-election she’s going to want to continue to take a tough-on-banks stance,” Litan said.
Regulators including Federal Reserve Chairman Ben S. Bernanke, Federal Deposit Insurance Corp. Chairman Sheila Bair, and former Fed Chairman Paul Volcker, now an adviser to President Barack Obama, oppose the provision because it could drive derivatives into unregulated parts of the market and to foreign competitors.
Customers will move their most complex derivatives trades to European banks such as Deutsche Bank AG (DBK), Credit Suisse Group AG (CSGN) or Barclays Capital if the legislation passes, say analysts including Brad Hintz at Sanford C. Bernstein & Co. in New York. Clients who want to buy protection will see a European bank as a stronger, better-backed credit than a U.S. derivatives subsidiary, Hintz said.
U.S. commercial banks held derivatives with a notional value of $212.8 trillion in the fourth quarter, according to the Office of the Comptroller of the Currency. The five banks with the biggest holdings of derivatives -- JPMorgan, Goldman Sachs, Bank of America, Citigroup Inc. (C), and Wells Fargo & Co. (WFC) -- hold $206.2 trillion, or 97 percent, of that total, the OCC said.
JPMorgan, the second-biggest U.S. bank by assets and the biggest dealer in the over-the-counter derivatives market, would be the most affected by the new rule, Barclays Capital analyst Jason Goldberg wrote in a note to investors today.
On April 14, JPMorgan Chief Executive Officer Jamie Dimon estimated the legislation’s new trading and capital requirements for derivatives could affect revenue by anywhere from “several hundred million to a couple billion dollars.”
The Securities Industry and Financial Markets Association, which represents JPMorgan and other large derivatives dealers, estimated the provision would require banks to find as much as $250 billion in new capital for the subsidiaries.
“It’s hard for me to come up with what’s a worse argument than that,” Date said. “That’s tantamount to saying, ‘Well, we’re undercapitalized today and we prefer to remain undercapitalized, thank you.”
Instead, he said, the industry’s argument should focus on the role that banks play in society.
“The whole reason for having a banking system is you want banks to be the primary intermediaries for credit risk and interest-rate risk,” he said.
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