NEW YORK By a vote of 60 to 39, the Senate passed an overhaul of financial regulations. President Obama is expected to sign it within days. Randall Lane, author of The Zeroes: My Misadventures in the Decade Wall Street Went Insane, reveals how Wall Street is already planning to get around the new rules.
At a recent lunch with a former financial regulator who now has a big job at a big bank, the topic turned to the financial reform bill Congress seems poised to pass Thursday. The market, this human Washington-Wall Street nexus told me with a sly smile, is always four years ahead of the regulators.
And that calendar, like the stock options of too many corporate scoundrels, apparently gets back-dated. Calling around Wall Street this week, I got the sense that the powers that beand their accountants and lawyershad been hard at work trying to end-run Wall Street reform before it even passed.
Its not going to affect us at all. Well move some stuff out, have some partial investments.
Since none of the dozen or so people I spoke withand virtually no one else in Americahas read all 2,000-plus pages of the windily named Dodd-Frank Wall Street Reform and Consumer Protection Act, lets consider this soon-to-be law in three mental buckets.
First, theres a big bundle of consumer protections. An independent Federal Reserve offshoot will make sure big banks dont gouge via credit cards, debit card fees, mortgages, and student and auto loans (though auto dealers somehow get an exemption, courtesy of their powerful lobby). These are good, smart policies that immediately feel as American as fried chicken and driving 80 miles an hourand other than preventing some types of predatory mortgage practices, they have precisely nothing to do with the last meltdown or the next one.
The second part deals with many of the systemic problems that nearly brought the economy down but that Congress proved too gun-shyor dysfunctionalto address directly right now, instead kicking decisions to nebulous regulators for determination down the road.
For instance, when banks grow too big to fail, a 10-person council of regulators, with the Treasury secretary at the helm, can opt to crack down on them if theyre healthy, or liquidate them if theyre not. For pay packages that encourage executives to take risks with other peoples money, the Fed will issue broad guidelines, rather than specific rules, and then try to block plans that run afoul of these nebulous standards. Credit rating agencies that slap high grades on lousy loans made by the banks who pay their bills will face more liability for such actions, which is goodbut regulators will also take two years to study further the inherent conflict of interest, which is like taking another two years to study further whether cigarettes cause lung cancer.
Realistically, though, the only part of financial reform that Wall Street was paying real attention to was the third area, which pertains to their ability to continue acting less like real banksmaking loans and helping companies raise money and other traditional services that prove the lifeblood of capitalismand more like the casinos they became over the past decade.
The big fight centered around the Volcker Rule, named for Obamas lanky Wall Street adviser, former Fed Chairman Paul Volcker, who pushed for a complete ban on proprietary, or prop, trading. This is the money a bank gambles for its own gain, often using customers deposits as the seed bet, borrowing wantonly above that to keep things extra interesting. The basic math encourages crazy risk: Hit it big, and bankers get a monster bonus; crap out, and the taxpayers sit on the hook for a bailout.
A strict Volcker Rule would have fixed that, and Wall Street shuddered accordingly. But after new Republican Senator Scott Brown extracted a watered-down versionbanks will be allowed to risk 3 percent of their capital via prop trading and own up to 3 percent of hedge funds and private equity fundsWall Street did what its best at: creating complicated solutions to exploit loopholes.
First, most banks are already content to bet tens of billions, given the leverage available, while sitting under the 3 percent threshold. For them, its business as usual. And rather than tamp down its prop operations, Wall Streets most aggressive firm, Goldman Sachs, is already talking about semantics: Renounce its standing as a bank holding company, so that it would no longer need to comply.
Similarly, even once banks rub up against the 3 percent, theyve already concocted another evasive maneuver: Keep the game, change the name. Specifically, Dodd-Frank allows banks to take the other side of a bet that a customer wants to make. You could say, Hey, Im doing this for my clients, one sales trader explained to me. Voila! Prop trading, under a new guise. The SECs recent lawsuit against Goldman, involving hedge fund billionaire John Paulson and a bunch of dubious subprime holdings called Abacus, details exactly how this shell game can work.
And that game continues with the hedge fund ownership limitation. Yes, banks instinctively would prefer to own more. But over the past few weeks, a new calculus has cropped up: rather than own hedge funds, the new law gives Wall Street cover instead to push in its customers (hey, were committed the full 3 percent the law allows!) and take a hefty, risk-free management fee: Dodd-Frank as marketing coup.
Finally, the reform package addresses derivatives, the dangerous multitrillion-dollar market of swaps and other Frankenstein-like Wall Street creations. The rules here will be exceedingly complicated. Banks will be allowed to play in some of these markets and will be banned from others. But on Wall Street, its fairly simple: Whats still OK will be done in the U.S. And what isnt, as one Wall Street partner told me, can just be pushed to overseas divisions.
Its not going to affect us at all, the partner shrugged, referring to Dodd-Frank. Well move some stuff out, have some partial investments.
But dont take this guys word for it. The Wall Street shell game can be viewed another waythrough those literal markets that always stay ahead of the regulators. Financial shares soared as the final deal clarified, partly because it removed uncertainty, which traders hate more than anything, but mostly because they realized that these rules allow them to continue pretty much business as usual. Wall Street is happy today. Historically, thats not a bad thinga robust financial industry generally produced wealth for allbut in these times, it sure seems to be.
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