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Fin Reg status and opinion

June 30, 2010

Tuesday was a busy day for the financial regulation reform bill with lots of deal-making machinations. Sen. Scott Brown (R-Mass.) was successful in forcing the bill back into conference where conferees removed most of the bank fees to hopefully win back his “yes” vote, along with votes from Senators Olympia Snowe (R-Maine), Susan Collins (R-Maine) and Charles Grassley (R-Iowa).

Democrats need some of these Republican votes. There’s no concrete word yet from the “on-the-fence” Senators after Tuesday’s deal making. Most pundits expect them to vote yes now and for this bill to be passed. I still think there is a chance for a surprise vote for cloture, which is what happened to the “tax extenders” bill that included tax increases on investment managers, professionals and global corporations.

Conferees used a creative-accounting scheme to re-jigger the TARP program — which no one in the media or Congress has explained properly yet — to “pay for” $11 billion of the bill’s costs. Republicans called this scheme budgetary smoke and mirrors and they may be right. The good news is they don’t charge big banks and hedge funds for these costs.

By the way, doesn’t $18 billion sound very high for oversight costs on these new regulations? The industry will have to match those costs anyway in paying for new employees, consultants, accountants and lawyers and for computers, software and services to comply with all this red tape. As with Sarbanes-Oxley, it’s an “employment act” for accountants and lawyers. Is this part of the government’s jobs program? Too much red-tape and compliance is a waste of money and it usually leads to fewer loans rather than more. Community-bank CEOs are writing editorials now about this problem, describing how this regulation will hurt their business and customers.

Conferees plugged the rest of the removed $18 billion with an increase to the FDIC levy rate. The current rate of 1.15 percent on total insured deposits is raised to 1.35 percent, and it’s scored to yield approximately $6 billion. The change would not affect banks with $10 billion or less in assets. Certainly, the FDIC can always use more money as it will need it to wind down more banks with a “Meltdown 2.0” knocking at our doors. Hedge funds are not covered by FDIC insurance, so they escape all charges with this bill change, at least for now.

This smells like a typical government deal with creative-accounting gimmicks, carve-outs and plugs to kick-the-problem-can down the road. I expect Democrats to try and raise taxes on banks, hedge funds and the investment industry. President Obama’s $90 billion bank fee or tax proposal to pay back perceived TARP losses is coming up next. Sen. Harry Reid (D-Nev.) is still trying to repeal carried-interest tax rules, thus raising taxes, for investment managers.

This last-minute drama over the bank fee (tax) doesn’t divert me from the overriding problem with this “Fin Reg” bill. The Resolution Authority’s wind down procedure calls for big banks and hedge funds to pay the ultimate costs of “winding down” financial institutions that fail. Winners pay for losers. It’s the same concept in the President’s $90 billion bank fee proposal too — the remaining big banks are being charged that new bank fee to pay for final TARP losses.

This is not socialism or communism, because government is not taking over industry, but it’s something else that is almost as disturbing in my view. It changes the dynamics of market-based competition. Should Apple pay for a failed competitor’s demise? Should Ford pay for GM’s unpaid TARP costs? Doesn’t this sound un-American? Study hard in school, build a great company, work hard, compete vigorously and then pay for the companies that don’t match your efforts and success. Isn’t this taking redistribution too far?

Congress and the administration will demand that banks and hedge funds pay a lot more in taxes, fees and other charges going forward, and the wind down procedure costs are not quantifiable or limited. How will CPAs account for this potential risk and cost on bank and hedge-fund balance sheets? Does hedge fund A need to state “Our strategy is x, y and z and here are the risks” in its private placement memorandum? By the way, if hedge funds B and C fail with a different strategy, we (including the investors) will be charged for their losses.

This Fin Reg bill is taking us down the wrong path. I hope Republicans show some back bone and vote against it, putting their fear of the midterm polls aside. It would be better to re-craft financial reforms in a more productive way with bi-partisan input, not just carve-out special deal making like Cornhusker-kickbacks.

Congress should not kick-the-can down the road on Fannie and Freddie and it should also address home buyers walking away from responsibilities on non-recourse loans. Look at the Canadian model. Canada didn’t have a problem with housing or its banks, because its home buyers have recourse loans and banks were not forced by the government to make sub-prime loans.

Congress should focus in on the real problems and not just demonize the banks. Prop trading and alternative investments are profit-centers; they aren’t bad banking. If Republicans don’t take a stand now, when will they? Waiting until the midterm elections in November is too risky in my view. Bi-partisan solutions on financial reform now will be better for everyone.

Latest developments
The House voted in favor of this reform today, but we have to wait until after the Fourth of July recess for the Senate's vote. Reid said there was not enough time procedure-wise to vote before the recess.

According to Reuters today, "’No, it's not amendable ... We don't plan on reopening the bill,’ Chairman Barney Frank (D-Mass.) said when asked if he is concerned that a delay in the Senate vote could provide an opening for lobbyists and critics to push changes to the legislation."

According to The Hill, Collins released a statement saying she would support the revised bill: "While the bill is not what I would have written and contains some provisions that I oppose, on balance I believe that it will lead to stronger financial institutions, curb the abuses that led to the near collapse of our financial markets, and improve financial oversight by creating a council of regulators to identify products, practices, and financial institutions that pose a systemic risk to our economy. Based on my initial review of the final version of the conference report, I am inclined to support it."

Additionally, The Hill reported that Brown issued a noncommittal statement on Wednesday.

“I appreciate the conference committee revisiting the Wall Street reform bill and removing the $19 billion bank tax," Brown said in the statement. "Over the July recess, I will continue to review this important bill."

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