Let's take a step back for a moment. Why do we even need financial reform?
I'm pretty sure it has something to do with preventing a repeat of the calamity that we experienced in 2008 and 2009. And by "calamity," I mean banks like Citigroup (NYSE: C ) and Bank of America (NYSE: BAC ) being handed hundreds of billions of taxpayer money because they're deemed "too big to fail."
Pretty simple, right?
Well, not if you count on Congress for a solution. When it comes to the simple task of protecting the U.S. financial system from the missteps of "too big to fail" banks, the financial reform bill that Congress finished up on Friday fails spectacularly.
How epic is the failure? Think about the Death Star engineering team that decided to leave an exhaust port exposed which, if hit just right, would cause the entire planet-sized ship to explode. We're talking about failure on that level.
A select few folks in Washington actually got it. Senators Sherrod Brown and Ted Kaufman introduced the SAFE Banking Act, which would have helped prevent "too big to fail" by -- stay with me now, this gets pretty complicated -- not letting banks get too big. But the rest of the rabble in the Senate soundly voted that proposal down.
Bring on the dogs and ponies
Instead of taking the simple route of combating systemic risk by limiting the size of financial institutions, Congress decided to dive into myriad other areas of finance and banking activities, eventually coming up with a massive, 2,000-page bill chock-full of loopholes big enough to squeeze Citigroup's bloated, prerecession balance sheet through.
Sure, there were some parts of the bill that seemed like good ideas. Sen. Blanche Lincoln's attempt to pull some of the crazy derivatives trading away from government-backed bank balance sheets certainly made sense. As did former Fed Chairman Paul Volcker's eponymous restriction against banks throwing capital at non-core-banking activities like proprietary trading and hedge funds. Not that either would really address the "too big to fail" issue, but at some point we've got to take what we can get.
Alas, even these provisions met the fate that you'd expect when congressional votes come from the people, but funding comes from the business (yes, banking) world. Namely, they were watered down to the point where they might as well have been taken out of the bill.
As I pointed out earlier in the year, mostly what the bill does is succeed in spades at creating more bureaucracy. All sorts of new bureaus, councils, and offices will be put into the mix, all with the general mandate to "make sure nothing bad happens." Which I'm sure will work out well. Though we had regulators in place before the crisis, obviously they were all idiots. The new guys will be much better.
What will it do? Who knows!
Celebrating the bill's completion on Friday, bill architect Sen. Chris Dodd said, "No one will know until this is actually in place how it works."
Perhaps if the bill wasn't 2,000 pages of pork and loopholes we might have a better idea right now what's going to happen once the bill's in place. Fortunately for Dodd, there were a few media outlets that seemed to have a pretty good idea what might be in store.
Over at CNBC, John Carney noted that with the Volcker Rule "adjusted" to allow banks to invest up to 3% of their capital in proprietary activities like investing in hedge funds, banks like B of A, Citi, and Morgan Stanley (NYSE: MS ) won't have to do anything at all to be in compliance.
And while Goldman Sachs (NYSE: GS ) , JPMorgan Chase (NYSE: JPM ) , and Wells Fargo (NYSE: WFC ) may have to pull back some of their hedge fund and private equity investments, Carney thinks this could be a positive for the banks. The banks actually make more money from managing private equity and hedge funds than on their own investments in those funds. Carney writes:
The new limit will now give the banks an excuse to reduce the amount of capital they commit to a hedge fund, which was mostly done to convince clients that the banks had "skin in the game." In fact, banks were being forced to commit more and more money to the funds to compete against other funds.
Similarly poignant was Andy Kroll, writing for Mother Jones, who took the bill to task on the watered-down derivatives legislation. In the final throes of bill-creation, banks managed to hang onto derivatives in areas like interest rates, foreign exchange, and gold. As Kroll points out, that's a huge chunk of the market:
In December 2009, the swaps trades exempted from the spin-off rule now in the bill accounted for almost $500 trillion in notional value, according to the Bank for International Settlements ... for some context, the total over-the-counter market at time was valued at $614 trillion.
As long as we're helping Senator Dodd get a sense of how this bill will work, I'll go ahead and throw out once more that it's not going to do a darn thing about "too big to fail."
Until next time
I've previously made the somewhat cynical suggestion that investors can pick up some short-term profits by going to the big banks as regulatory uncertainty departs and profits return. I wish I could say I no longer stand behind that.
Longer term, though, the big banks still worry me and it seems like we're being set up for another financial crisis down the road. I guess we'll just have to cross our fingers that Uncle Sam gets it right the next time around.
You know what I do when politics get me down? I close my eyes and think about dividends.
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