Is Dodd-Frank being rolled back while no one is looking?
It’s par for the course for the GOP-controlled House to pass bills that few people notice and that ultimately go nowhere. But it’s rare for legislators to join hands across the aisle to roll back parts of President Obama’s signature legislative achievements. That’s what happened on Monday, when the House passed two little-noticed bills that changed the derivatives rules under the Dodd-Frank Act.
Both bills would place new limitations on regulating derivatives, the complex transactions that Commodity Futures Trading Commission Chairman Gary Gensler recently described as “the largest dark pool in our financial markets.” As Reuters explains, one bill provides an exemption for businesses that use derivative hedges to shield themselves against real-world risks — e.g. airlines protecting themselves against oil price spikes, farmers against fluctuating grain prices, known as “commercial end users” — so they don’t have to hold cash reserves to back up deals known as swaps. It passed the House overwhelmingly, 370 to 24.
The other bill, Reuters reports, would protect derivatives deals “between affiliates of the same company from clearing, execution, capital and margin requirements.” In other words, deals conducted between two affiliates of the same company essentially wouldn’t be subject to all of the major new derivatives regulations. That bill passed on a 357-to-36 vote.
The rationale behind both bills is that they are “technical” fixes meant to prevent unintended, adverse consequences to the firms subject to new regulation. During the original debate over Wall Street reform, commercial users of derivatives fought — successfully — to exempt themselves from other new regulations, arguing that they weren’t using the products to gamble, like Wall Street, but to hedge against normal business risks. Defenders of the second bill point out that companies put all the transactions of their affiliates on the same book, which is ultimately overseen, so it’s redundant and burdensome for internal swaps to be regulated in the same way.
But critics of the bills, like Americans for Financial Reform, believe that the legislation could make substantive changes to Dodd-Frank that would increase risk and instability in the marketplace. By exempting end-users from margin requirements, corporations and Main Street firms could make bigger, riskier trades using derivative swaps, as they won’t be required to have cash reserves on hand in case the deals went bad.
“This can cause a liquidity crisis at the very time that the company is most vulnerable, resulting in a death spiral,” Wallace Turbeville, a former Goldman Sachs vice president who now advocates market reform, wrote in 2010 during the Dodd-Frank debate. What’s more, some corporations that call themselves end users are actually acting as covert hedge funds, making swaps to profit rather than to hedge risk for their primary business. Similarly, the critics argue, banks will be able to conduct bigger, riskier swaps between their own affiliates, essentially removing them from all regulatory authority.
Previous bills to roll back Dodd-Frank have essentially been dead on arrival in the Senate. The same could hold true for these two, but the majority support from House Democrats might prompt their Senate counterparts to at least take a second look.