A group of high-profile Democrats and a top Republican on Wednesday launched a campaign to pressure Capitol Hill leaders to remove a provision in a must-pass government funding bill that would eliminate big banks' obligation to spin some of their derivatives business into separately capitalized subsidiaries.
"We had scores [of Democrats] that agreed with me and said they would not support this legislation if this stays in," Rep. Maxine Waters, D-Calif., told reporters at a press conference. "It should never be slipped into the [appropriations] bill. We shouldn't allow the biggest banks in this country to do this risky derivatives trading instead of doing the 'push out' that would put it into subsidiaries that don't have the protection of the [Federal Deposit Insurance Corp.]."
Known as the Lincoln Rule, after former Arkansas Democrat Sen. Blanche Lincoln, the statutory obligation was part of the Dodd-Frank financial reform law and requires big banks to make riskier credit derivatives trades in a separately capitalized unit. The aim of the provisions to ensure that a trading failure there would not have affected the institution's commercial bank division, which is backed by insured deposits and taxpayers through the Federal Reserve's discount window. This kind of trading led to trouble for American International Group (AIG) during the early stages of the financial crisis.
A provision removing the measure was added to a government spending bill as part of a compromise between Democrats and Republicans that includes hikes in appropriations to the Securities and Exchange Commission and Commodity Futures Trading Commission for their enforcement budget.
The Federal Reserve has yet to propose rules based on the provision, even though it was scheduled to take effect in July, 2013. Jaret Seiberg, analyst at Guggenheim Partners, suggests that the measure has "come under fire" from the Fed and that gives "lawmakers political cover" to back the measure. Both former Fed Chairman Ben Bernanke and Sheila Bair, the former FDIC chief, have raised concerns about the provision and argued it would push swaps into less regulated markets.
Opponents of the Lincoln Rule say removing it ensures that big banks can continue to conduct a variety of risk-mitigating hedging for clients in the same way that farmers and manufacturers use certain derivatives to protect against commodity price fluctuations. A former top FDIC official said that forcing big banks to move certain derivatives to separately capitalized units would have the unintended consequence of making it "not worthwhile" for big banks to employ them and the result would be to drive significant derivatives business to unregulated markets and hedge funds that are less closely monitored by bank and securities regulators.
Nevertheless, Tom Hoenig, the vice chairman of the Federal Deposit Insurance Corp., defended the Lincoln Rule in a statement. He called it an important step in "pushing the trading activity out to where it should be conducted: in the open market, outside of taxpayer-backed commercial banks."
Hoenig, a Republican, noted that most derivatives transactions -- including those used for hedging -- would still remain in the commercial bank even if the provision becomes law. That's because more plain-vanilla derivatives, including interest rate swaps, foreign-exchange and cleared credit derivatives, could remain at the bank. Uncleared credit default swaps, equity derivatives and commodities derivatives, would be pushed to separately capitalized units.
Sen. Elizabeth Warren, D-Mass., told reporters that the measure would help a handful of institutions that have big commercial banking and investment banking units. "This is a handful of institutions [that are helped]," Warren said. "This doesn't help everyone on Wall Street. This only helps the ones that have a [commercial] banking tie. What is in here is risky and it is risky for our economy."
According to a person familiar with the measure, repealing the Lincoln Rule would be the most help to Citigroup Inc. (C) , Bank of America Corp. (BAC) and JPMorgan Chase & Co. (JPM) , which have large investment banking and commercial banking units that conduct their CDS, equity and commodity derivatives business inside their commercial bank.
In addition, a few left-leaning organizations, including Demos, Better Markets and the AFL-CIO labor union also issued statements opposed to the change.
Former Rep. Barney Frank, D-Mass., the co-author of the Dodd-Frank Act, issued a statement urging his former colleagues to reject the appropriations bill because of its "stealth attack on financial reform." And Sen. Sherrod Brown, D-Ohio, suggested that it was a "giveaway to Wall Street" that would open the door to future taxpayer-backed bailouts.
Discussions about the spending bill and amendments to it are expected to go on tonight, according to Waters. It is unclear whether opposition by Democrats could derail spending bill negotiations and force a government shutdown.