Remember the Lincoln amendment? Passed as part of Dodd-Frank, it prohibits firms that trade in certain kinds of derivatives from receiving government assistance, with the intent of making big bank bailouts less likely.
The Lincoln amendment — also known as section 716 — prevents firms that receive FDIC insurance or access to Fed credit lines from carrying out certain kinds of derivatives trading, like the credit-default swaps that helped bring down AIG. It doesn’t go into effect until July, but it will effectively force big, government-backed banks to spin off a portion of their swaps trading into separate subsidiaries and affiliates that don’t receive federal assistance. The repeal bill, which the House Financial Services Committee brought up this week, would essentially prevent this from happening. It’s authored by Rep. Nan Hayworth (R-N.Y.), a GOP freshman who believes that prohibiting banks from conducting a fuller range of derivatives trading will simply push risk into less-regulated areas of the market.
“While the authors of 716 presumably intended to decrease risk, 716 actually increases risk by pushing swaps activities into entities that are not directly regulated by the FDIC and the Office of the Comptroller of the Currency,” Hayworth said in a statement. She adds that it also imposes “onerous” costs for banks who have to spin off these trading operations.
Frank, for his part, doesn’t believe that there will be a particularly negative impact if the prohibition stays in place. But he admits that it’s possible that the law could add unnecessary complications to derivatives regulation and believes its repeal wouldn’t make bailouts any more likely. “I don’t think it’s essential to the bill,” he tells me. “It in no way affects the regulation of derivatives ... this does not weaken the very strong anti-taxpayer bailout situation.” As such, the Massachusetts Democrat says that he’d support Hayworth’s bill.
House Democrats, on the whole, weren’t crazy about the Lincoln amendment when Congress was first deliberating the proposed derivatives regulations. The amendment ended up being watered down after both industry players and prominent Democratic allies warned that it would weaken banks’ ability to protect their customers by barring them from using derivative swaps to hedge risks. The earlier criticisms echo Congress’ current complaints about the ban. “Section 716 would force derivatives activities out of banks and potentially into less regulated entities or into foreign firms ... [which] would increase, rather than reduce risk to the financial system,” Federal Reserve Chairman Ben Bernanke wrote in May 2010, when the Lincoln amendment was being deliberated.
Advocates on the left, however, are adamant that the ban remain in place, arguing that it forces banks to put up greater collateral to back up risky bets. “It is a form of firewall between swaps dealing and the rest of your operations, requiring separate capitalization,” says Marcus Stanley, policy director of Americans for Financial Reform. “When you allow banks to do absolutely unlimited derivatives activities, it’s hard to separate banking from speculation.”
With support from some prominent Democrats, Hayworth’s bill stands a better chance of passing than most of the Dodd-Frank reform bills that Republicans have pushed thus far. That said, while House Democrats might not put up a fight to stop the repeal bill, their Senate counterparts might feel otherwise.