Backlash against bailouts and bonuses makes it harder for Wall Street to kill financial reform in Washington. But lobbyists have sidestepped some of the harshest proposals
By Alison Vekshin and Michael J. Moore
(Bloomberg)—Four Wall Street lobbyists and about a dozen lawmakers huddled over eggs and bacon at Tortilla Coast restaurant on Capitol Hill on Dec. 2 to discuss legislation aimed at strengthening bank regulation.
The meeting between fiscally conservative House Democrats and lobbyists for the largest U.S. financial firms turned tense, with a lot of finger-pointing, recalled one attendee. The message delivered over breakfast: We bailed you out last year with taxpayer dollars. Now help us address the needs of constituents by aiding struggling homeowners and lending more.
The backlash against bailouts and bonuses is making it harder for Wall Street to get its way as lawmakers redesign the framework for financial oversight. The biggest banks may be forced to submit to a new regulator for mortgages, credit cards and other consumer products; put $150 billion into a fund the government will use if they collapse; and pay more to insure deposits. Still, the firms that helped precipitate the worst financial crisis in 70 years have so far sidestepped proposals that would have split investment and commercial banking, capped pay or seriously hurt their ability to make money.
"The industry is not losing as badly as it thought it might," said Oliver Ireland, a former associate general counsel at the Federal Reserve and now a partner at law firm Morrison & Foerster in Washington. "The fact that someone had a worse proposal on the table and it doesn't happen — it's hard to view that as a win. It's not as big a loss."
That banks are making any headway "is astonishing," said Travis Plunkett, legislative director at the Washington-based Consumer Federation of America.
"Some members of Congress seem to have memory loss," Plunkett said. "They are forgetting that the very institutions whose amendments they're proposing were the entities that helped cause our nation's financial collapse. The banks are playing death by 1,000 cuts."
The House last week passed a package of measures to create a Consumer Financial Protection Agency, bolster oversight of derivatives and hedge funds, limit incentives in executive pay that spur excessive risk-taking and set up a mechanism to dismantle large firms that fail. The bill reflects the set of regulatory proposals President Barack Obama released in June.
The Senate has yet to consider a bill and isn't expected to vote on one until at least early next year. The Senate Banking Committee is reworking a draft released last month by Senator Christopher Dodd, the committee chairman, after Republicans complained that it would expand the government's powers too far. The lack of consensus in the Senate may offer more opportunity for lobbyists to mold and defeat parts of the legislation before it reaches a vote.
'Water It Down'
"Wall Street is probably happy with the slowness of the process because the slower the process is, the more you can drag it out and water it down," said Paul Miller, an analyst with FBR Capital Markets in Arlington, Virginia. "Right now, all the energy and political capital is going into health care."
Whatever legislation emerges, it likely won't reintroduce aspects of the 1933 Glass-Steagall Act that would split commercial and investment banking. That idea, which could lead to the breakup of large banks such as Bank of America (BAC) and Citigroup (C), has won support from Bank of England Governor Mervyn King and former Federal Reserve Chairman Paul Volcker, now head of the U.S. Economic Recovery Advisory Board. No such proposal is in current legislation before Congress.
Wall Street also pushed back with some success against proposals to regulate derivatives, such as one put forward by Senator Tom Harkin, an Iowa Democrat who served as chairman of the Senate Agriculture Committee until September, that would have required all contracts be conducted on regulated exchanges.
Derivatives contracts, including credit-default swaps, are used by companies to protect against swings in commodity prices, interest rates and other operational risks. Trading them on exchanges would carry transaction costs and crimp one of Wall Street's most lucrative businesses. The top five U.S. commercial banks were on track at the end of the second quarter to earn $35 billion in over-the-counter derivatives trading this year, according to a review of company filings with the Fed and people familiar with the banks' income sources.
Much of the lobbying was conducted by the Coalition for Derivatives End-Users, a trade group that represents companies such as Apple Inc. and Johnson & Johnson. The group asked banks not to join their negotiations with lawmakers for fear that the unpopularity of the financial industry would harm their case, according to people familiar with the discussions.
Under the House bill, banks will still be able to trade customized derivatives contracts over-the-counter. Because of choices about where trades can be executed, few standardized contracts may be pushed onto exchanges. Airlines, energy companies and other corporate end-users that rely on derivatives would also be exempt from most new requirements.
"The OTC reform has gotten to be basically irrelevant as far as change," said Chris Whalen, managing director of Institutional Risk Analytics in Torrance, California. "There are some things in there that are irritating to the Street, but compared with what we thought we were going to get over the summer, it's night and day."
The New Democrat Coalition, a group of 68 pro-business lawmakers in Congress, has succeeded in making changes in the House bill sought by the industry. One involved the issue of whether the federal government can override states in applying consumer protection laws.
National banks sought to keep states from applying tougher laws, saying they wanted to avoid having to comply with a patchwork of state regulations.
New Democrats delayed House consideration of the reform bill on Dec. 9 to force negotiations on an amendment offered by Representative Melissa Bean, an Illinois Democrat and vice chairman of the coalition, to expand the power of federal regulators to override state laws from what was in the bill.
Instead of starting debate on legislation that was six months in the making, House Financial Services Committee Chairman Barney Frank, House Majority Leader Steny Hoyer and House Rules Committee Chairwoman Louise Slaughter marched into a meeting in the offices of Speaker Nancy Pelosi on the second floor of the U.S. Capitol.
Frank, who introduced the financial overhaul legislation, and other House leaders were in one room, while Bean and Treasury officials were in another. Hoyer shuttled back and forth, according to a person familiar with the matter.
An hour later, shortly after 6 p.m., Frank emerged from the meeting and told reporters a deal had been reached. A version of Bean's proposal would be included in the bill.
"The differences have been narrowed, and I think you're getting something that both sides can live with," said Frank, a Massachusetts Democrat.
Debate on the bill began at 6:49 p.m.
"Some of the big banks had a successful run at lobbying the New Democrats," including on the preemption issue, Frank said in a Dec. 10 interview.
Public outrage over the industry's role in the financial crisis and the bailout it got from the $700 billion Troubled Asset Relief Program has made lawmakers less willing to seek input from Wall Street than in the past, several lobbyists said.
Wall Street Bonuses
Two-thirds of Americans say they have an unfavorable view of financial executives, making them less popular than members of Congress and lawyers, according to a Bloomberg National Poll of 1,000 U.S. adults conducted Dec. 3-7.
Obama said in an interview with CBS's "60 Minutes" program yesterday that he is frustrated that "fat-cat bankers" are continuing to pay out large bonuses and fighting his effort to revamp financial regulations. He will host a meeting today with executives from 12 of the nation's largest banks to discuss his proposals to overhaul regulations and boost small-business lending, an administration official said.
Wall Street year-end bonuses will be announced in January as the Senate likely debates a bill. That could prompt another wave of anger, emboldening lawmakers.
"The regulatory and political risk is real," said Jason Goldberg, a senior bank analyst at Barclays Capital in New York. "Talking to bank CEOs looking toward next year, I think for most it's their No. 1 risk, ahead of the economy and ahead of asset quality, because a lot of it is just unknown."
The biggest threat to Wall Street may be an amendment introduced by Representative Paul Kanjorski, a Pennsylvania Democrat and a member of the House Financial Services Committee, that would let regulators dismantle healthy, well-capitalized financial firms whose size could threaten the economy.
Industry lobbyists failed to kill the amendment, which passed as part of the House legislation last week.
'Kind of Nuts'
"It's just frankly kind of nuts," Steve Bartlett, president of the Financial Services Roundtable, a Washington- based industry trade group, said in a Nov. 18 Bloomberg Television interview. "It is the large companies that provide almost all of the financing for the economy as a whole. You can't finance this economy with a hundred small banks on the corner."
Rob Nichols, president of the Financial Services Forum, which represents the chief executive officers of 18 of the largest financial firms, said in an interview that he tried to convince Kanjorski, Frank and other lawmakers to drop the provision, arguing that larger firms aren't necessarily riskier and that the proposal would put U.S. firms at a competitive disadvantage with their overseas rivals.
"The industry needs to understand that the system was broken going into this and needs to be fixed and the status quo is not acceptable," Federal Deposit Insurance Corp. Chairman Sheila Bair said in a Dec. 3 interview. "There's a core need for reform, and they need to understand that and work with Washington to accomplish it in a way that strengthens our markets and not oppose it."
Lawmakers have been friendlier to smaller banks, which persuaded House members to exempt lenders with less than $10 billion in assets from examination and enforcement by the new consumer protection agency. While the agency will set rules for smaller banks, their primary regulator will examine them for compliance and crack down on violations. The exemption applies to 99 percent of the nation's 7,996 banks.
The agency, an idea proposed by Obama to police banks for abuses against consumers in credit-card and mortgage lending, was the industry's prime target. Bank officials lashed out against the plan, saying a standalone agency isn't necessary, since bank regulators already have the authority, and that it would increase the cost of credit.
They didn't prevail. The House last week rejected an amendment that would have cut the agency from the bill.
"What planet are you living on?" Dodd said of industry opposition to the agency at a June 18 hearing. "The very people who created the damn mess are the ones now arguing that consumers ought not to be protected."
Even so, Wall Street was able to score some victories with the consumer agency. The House legislation does not require financial institutions to offer so-called plain-vanilla products and services or assess whether consumers understand the products they offer, as Obama wanted.
The bill empowers regulators to ban incentive pay that encourages risk-taking and requires all public companies to give shareholders a non-binding vote on top managers' compensation. Neither the House bill nor the Senate draft sets limits on pay or requires specific periods for deferring bonuses and holding stock, such as French President Nicolas Sarkozy demanded and Treasury's special pay master Kenneth Feinberg imposed on companies that needed exceptional government assistance.
Another concession involved a provision that requires creditors and companies that package loans into securities to retain on their books as much as 10 percent of the credit risk on all loans. The measure, which the industry had argued would eliminate securitization, was amended to limit the industry's stake to 5 percent.
The House also rejected a mortgage "cram-down" amendment, opposed by banks and broker-dealers, that would have given federal judges the power to lengthen mortgage terms, cut interest rates and reduce loan balances for homeowners in bankruptcy court.
Some provisions of the House bill will hurt Wall Street, especially the biggest banks. They will have to pay a greater share of fees to the FDIC's deposit insurance fund, and banks with more than $50 billion in assets will be assessed charges to finance a separate $150 billion industry-supported fund to cover the failure of a large systemically important financial firm.
The industry argued that having firms pay into the fund before a collapse would tie up money that may never be used. Frank, who initially supported an Obama administration proposal to assess fees after a large firm failed, reversed course, saying waiting until after the fact would require going to the taxpayer first and then having the industry repay the government.
Another amendment opposed by Wall Street and approved by the House would force secured creditors to bear losses of as much as 20 percent to help cover the cost of unwinding a failed systemically important financial firm. Banks say the measure will increase borrowing costs and disrupt credit markets.
"We were their best friends when they needed TARP money to dig them out of the mess that they put themselves in," said Representative Luis Gutierrez, an Illinois Democrat and chairman of the House Subcommittee on Financial Institutions and Consumer Credit, who introduced the proposal for the $150 billion resolution fund. "The folks at Goldman Sachs are distributing billions of dollars. We made it possible. It's shameless that they should be using their profits to stop the American people through this legislative process."
To contact the reporters on this story: Alison Vekshin in Washington at firstname.lastname@example.org; Michael J. Moore in New York at email@example.com.