The Republican Strategy to Deregulate Wall Street

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Update: House Republicans held another vote on the financial regulatory changes Johnson writes about below on Wednesday and the measure passed easily, with a vote of 271 to 154. Watch for further developments as early as next Tuesday, and be aware that this legislation is still under the radar for most media coverage. Dodd-Frank is being rolled back without any open discussion or scrutiny. And the question remains: Why are the House Republicans so keen to avoid a hearing on the substance of their proposals to effectively repeal the Volcker Rule? And will Senate Republicans proceed in the same manner?

This is a version of a post that originally appeared at Baseline Scenario.

On day two of the new Congress, the House Republicans put their cards on the table with regard to the 2010 Dodd-Frank financial reforms. The Republicans will chip away along all possible dimensions, using a combination of legislation and pressure on regulators — with the ultimate goal of relaxing the restrictions that have been placed on the activities of very large banks (such as Citigroup and JP Morgan Chase).

The initial target is the Volcker Rule, which limits the ability of mega-banks to place very large proprietary bets – and their ability to incur massive losses, with big negative consequences for the rest of us. It was that type of Wall Street risk-taking that led to the 2008 financial crisis. But we should expect the House Republican strategy to be applied more broadly, including all kinds of measures that will reduce capital requirements (i.e., making it easier for the largest banks to fund themselves with relatively more debt and less equity, taking more risk while remaining Too Big To Fail and thus benefiting from larger implicit government subsidies.)

House Republicans are moving in several stages to reduce the scope of the Volcker Rule and to gut its effectiveness.
The repeal of Dodd-Frank will not come in one fell swoop. Rather House Republicans are moving in several stages to reduce the scope of the Volcker Rule and to gut its effectiveness.

The first step in this direction came on Wednesday, with a bill brought to the floor of the House supposedly to “make technical corrections” to Dodd-Frank. This legislation was not considered in the House Financial Services Committee, and was rushed to the House floor without allowing the usual debate or potential for amendments.

Buried in this legislation is Title VIII, which will extend the deadline for one important aspect of Volcker Rule compliance to 2019. At issue is the deadline for big banks to shed their Collateralized Loan Obligations, which are mainly backed by commercial loans to higher-risk companies. They are effectively hedge funds, which the Volcker rule prohibits banks from owning due to their risky nature. (See this primer from Better Markets, a pro-reform group.)

Some very large banks and House Republicans previously asked to extend this deadline for CLO compliance through 2017, and a full extension was actually granted by the Federal Reserve in 2014. Specifically, in April 2014 the Fed extended the divestment deadline for CLOs to 2017 and then, in December 2014, extended the divestment for all covered funds under the Volcker Rule until 2017.

Now that Citigroup, JP Morgan Chase and Wells Fargo already have the extension through 2017, they immediately ask for, you guessed it, another extension, this time through 2019.

The strategy here is clear: delay for as long as possible. Perhaps the regulators will cave in, again, under pressure.

The strategy here is clear: delay for as long as possible. Perhaps the regulators will cave in, again, under pressure. Perhaps the White House will agree to another rollback of Dodd-Frank, for example attached to a spending bill – which is what happened in December 2014. Remember that government spending is only authorized until September 2015, so there will be plenty of opportunities.

And perhaps, after November 2016, a Republican president will work with a Republican Congress to eliminate all parts of Dodd-Frank that crimp the style of very large leveraged financial firms.

On Wednesday, the Republican bill that would have weakened the Volcker Rule actually failed. It needed two-thirds of all members present in order to pass, and the vote was 276 in favor and 146 against. When enough Democrats hold together, they can make a difference. But, as the Associated Press reported, the measure is likely to pass soon under rules that require a simple majority.

But all of this is just a warm-up. In coming months we should expect: the largest few banks — always masquerading as representing the social interest — will pressure for a change in technical definitions, e.g., what kind of hedge fund they are allowed to own and what it means to “own” something. They will ask for more delays and “clarifications”. And they will argue that lending to some category of firms (“job creators”) should be exempt from any kind of restriction.

Section 716 of Dodd-Frank, which would have forced big banks to keep their derivatives business somewhat separated from their insured deposits, was repealed in December 2014. The repeal of this measure primarily benefited Citigroup and JP Morgan Chase. At the time, some Democrats – including people close to the White House – said, not to worry, “we’ll always have the Volcker Rule.”

In fact, the signal from the repeal of Section 716 is that the store is open. The White House had previously said “no” to any proposed repeal of Dodd-Frank, including when attached to a spending bill. This moratorium has clearly been lifted, and the lobbyists are hard at work.

The House Republican rhetoric will be “technical fixes” and “job creation”. But the reality is that they are determined to strip away all meaningful restrictions imposed on Citigroup, JP Morgan Chase and other mega-banks — and to roll-back Dodd-Frank as far as possible, until it becomes meaningless or they are finally able to repeal it completely.

Editor’s note: See this Bill Moyers interview on the need for regulation — and efforts to roll it back — from Paul Volcker, the man behind the Volcker Rule:

The views expressed in this post are the author’s alone, and presented here to offer a variety of perspectives to our readers.

Simon Johnson is a professor at MIT, a senior fellow at the Peterson Institute for International Economics and a former chief economist at the International Monetary Fund. He was recently named a “Main Street Hero” by the Independent Community Bankers of America (ICBA). Follow him on Twitter: @baselinescene.
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