The Wall Street-Washington Divide

By David Rogers
|  Thursday, Apr 29, 2010  |  Updated 5:18 PM EDT
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The Wall Street-Washington Divide

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Goldman Sachs chief Lloyd Blankfein (left), Senate Agriculture Committee Chairwoman Blanche Lincoln (right)

For all the money that has moved back and forth between Wall Street and Washington in recent years, what’s most striking is how little each understands, still, about the other.

When young executives from Goldman Sachs appeared before a Senate panel Tuesday, members were taken aback by what they viewed as an arrogant and condescending tone; “smart asses,” said one conservative Republican. Yet by afternoon, there were flashes of sympathy for Goldman chief Lloyd Blankfein as he tried to get senators to appreciate his pride in making the markets work — not just in profiting from “short” and “long” bets on derivatives.

All this comes to bear now in a few lines in the giant bill that would force major banks to spin off their swaps operations or lose all federal aid, including access to the Federal Reserve’s discount window. And Wednesday’s agreement to begin debate means the issue could be joined as early as Thursday, when Democrats take up their revised derivatives language — including this Section 716.

The restrictions go beyond even the “Volcker rule” associated with the former Fed chairman, Paul Volcker, an adviser to President Barack Obama. And since just five commercial banks — including Goldman, JPMorgan Chase and Morgan Stanley — account for 97 percent of the value in the derivatives market, it’s seen as a direct hit on Wall Street, provoking a fierce reaction.

Sen. Judd Gregg (R-N.H.) was almost apoplectic this week in a floor speech condemning the provision as an ill-informed attempt to really rough up Wall Street — not reform it.

“It is penal. That is the purpose of this: punitive,” said Gregg. “In the end, it is going to cut off our nose to spite our face.”

“Rampant pandering populism” was his favorite catchphrase; that and Argentina under Juan Peron in the 1950s.

The Treasury — albeit considerably calmer — shares some of his concerns. An unusually aggressive memo from the Federal Reserve staff recommends outright that the provision be deleted. But at the insistence of Senate Agriculture Committee Chairwoman Blanche Lincoln, it remains. The Arkansas Democrat has touched a chord among senators wanting to break up the concentration of power in a few banks and put the focus back on traditional lending, not speculative trades.

“If they want to do swaps, there’s no problem with them wanting to be in this business,” Lincoln told POLITICO. “But they need to separate themselves out so they are not putting at risk the depositors from the bank. And I don’t think that’s an unreasonable thing to ask.”

“They can do it. They just have to separate it out. They have to capitalize it on its own. They can’t capitalize it from the depositors at the bank.”

Nonetheless, Volcker, who remains an icon for many in Congress, has proposed a more qualified ban: allowing banks to operate a derivatives business to serve their customers but not to trade among themselves or take positions on a proprietary trade. 

For example, if a big Wall Street bank were asked to offload a large block of stock for a retirement investment fund, it might decide to do so in increments, so as to guard against any sudden impact on the markets. Since those stock transactions could then take some time, Volcker would allow the bank to protect itself — and its depositors — by generating derivatives as a hedge on the stock price.

Lincoln said she’s not fazed by going beyond Volcker. But as she explained her language, she also seemed to be leaving some room for compromise. Bank holding companies could have swap operations — separate from the bank itself, for example. And she said she is not opposed to a bank’s buying a swap to protect itself but that it ought not to be the dealer.

“They can still use a derivative as a risk-balancing tool,” Lincoln told POLITICO. “They just can’t be a major swap dealer.”

Watching from across the Capitol, House Financial Services Committee Chairman Barney Frank (D-Mass.) said that Lincoln’s comments did leave room for compromise.

“The question is whether there is a legitimate need for commercial banks, including small ones, to be able to hedge their own risks,” Frank said in an interview. “If that’s made clear, then there is no problem.”

“There’s a bit of a push-pull in this. I believe the consensus will be, they can’t be dealers, they can’t be major players, but they should be allowed to hedge their own commercial risk.”

“Volume becomes very important for the regulators,” Frank said, imagining some conversation in the future when a regulator asks a bank: “‘You’re saying you’re hedging your own risk, and you’re way out there?’”

“I like the idea that banks don’t have other profit centers,” the chairman said, smiling. “They’ll have to lend more money.”

Gregg warned that separating the banks from swaps operations will create less credit, not more, since the new independent entity will drain away capital to meet its own needs.

“Where it comes from, quite honestly, is the creditworthiness of other activity. ... It will cause a contraction of about $700 billion of credit in this country.”

Within Democratic ranks, Lincoln’s activist stance is not without some irony. In the run-up to her committee markup last week, Treasury officials had portrayed her as being too weak on derivatives regulation and took credit for turning her around. But she’s now gone further than the administration expected — and left Treasury in a position where it now looks like it’s defending the Wall Street banks from a more populist Congress.

Treasury Secretary Timothy Geithner didn’t help himself in this regard by failing to even meet with the new chairwoman before her markup. And given his own history with the New York Federal Reserve and dealings with many of the same Wall Street interests, it’s the Lincoln camp that now suggests he ought to be on the defensive.

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