Congress Approves Financial Reform, Scott Brown Gets His Volcker Rule Loophole

AP090204020284Early this morning, at about 5:40 a.m., the conference committee reconciling the House and Senate’s respective versions of financial regulatory reform finished its work, with the House conferees approving the reconciled legislation on a 20-11 vote and the Senate approving it 7-5. Both votes were party line, with Democrats in favor and Republicans opposed. The bill was officially renamed the Dodd-Frank bill, after Senate Banking Committee Chairman Chris Dodd (D-CT) and House Financial Services Committee Chairman Barney Frank (D-MA).

Before I start complaining about what went on last night, I should take a moment to note that this bill has many strong provisions that will help create a safer, more stable, and fairer financial system that does far more than the current one to protect consumers and rein in Wall Street excess. It creates a new consumer protection regulator, a resolution authority for dismantling failed banks without taxpayer money, and crafts a regulatory regime for derivatives where currently none exists. These are all significant achievements.

However, there were also some unsavory compromises worked out by the conferees overnight that will render the bill less transformative than it could have been. For instance, while a stronger version of the Volcker rule — a ban on banks trading for their own benefit with federally insured dollars — proposed by Sens. Carl Levin (D-MI) and Jeff Merkley (D-OR) was included, conferees added an exemption to the rule sought by Sen. Scott Brown (R-MA) that allows banks to continue to invest money in risky hedge funds and private equity firms.

Not only was Brown’s exemption included, but negotiators decided to allow banks to invest three percent of what’s known as Tier 1 capital, as opposed to three percent of what’s known as tangible common equity (TCE). This is a huge distinction, as banks have far more Tier 1 capital than TCE. As Shahien Nasiripour explained, this small change means that banks can place bets with billions of dollars more than was envisioned by the original Volcker rule proposal:

Using JPMorgan Chase, the nation’s second-largest bank by assets with more than $2.1 trillion, as an example, the bank would be able to invest an additional 40 percent of its cash, or more than $1.1 billion, in the activities that Volcker wanted to prohibit banks from engaging in, according to the firm’s latest annual filing with the Securities and Exchange Commission.

Permitting banks to invest in risky entities strikes at the very heart of the Volcker rule, as former Federal Reserve Chairman Paul Volcker himself has said. “Allowing a bank to invest in a speculative fund goes against the very intent of the bill as we seek to define those activities that are worthy of government protection,” he said.

The bill now moves to one more vote in each chamber of Congress before going to the President for his signature. Conference reports can’t be amended.