Last week, an epic fight was waged in Congress over the repeal of a key part of Wall Street reform meant to prevent future bailouts. A firestorm ensued in the halls of Congress, pitting Democrats against Democrats, and the Obama administration against progressives. In the end, as usual, Wall Street got what it wanted. But the industry was left hemorrhaging credibility. And the defense mounted by Citigroup has done nothing to stanch the bleeding.
First, a quick recap. The year-end spending bill included a near-total repeal of Section 716 of Dodd-Frank (2010's Wall Street reform bill). Section 716 is also known as “swaps pushout,” and it required that big banks push certain derivatives out of the part of the bank that enjoys FDIC insurance. The spending bill, with the swaps pushout repeal intact, was ultimately passed by both chambers of Congress (219–206 in the House, and 56–40 in the Senate).
Those who opposed the repeal went down fighting, and fighting hard. The battle pitted progressive Democrats against President Obama, who was personally making calls trying to whip votes for the spending bill (some lawmakers noted it was the first time in six years they’d heard from him). JPMorgan CEO Jamie Dimon also made personal phone calls to Congress in favor of the pushout repeal. Progressives in the House balked, repudiating both the Obama-Dimon tag team, and the repeal itself. Many members of Congress pointed out that the language of the repeal was written by Citigroup lobbyists, a point hammered in the press.
But no one hammered Citigroup more than Senator Elizabeth Warren, who on the evening of Dec 12 gave a nearly ten-minute speech focused entirely on the bank. She noted the plethora of Citi alumni at the Treasury, and the nearly half-trillion in bailouts and government assistance they required. In the speech’s most stinging part, she addressed Citigroup directly: “Let me say this to anyone who is listening at Citi. I agree with you: Dodd-Frank isn’t perfect. It should have broken you into pieces.”
All told, last week Senator Elizabeth Warren called out Citigroup by name 32 separate times across three speeches:
Prior to Warren’s Citigroup speech, the bank tried to tell their side of the story, in a blog. The post, written by the EVP for Global Public Affairs, Ed Skylar, lays out their argument for repealing swaps pushout. The post alleges, “Pushing derivative activity into less-regulated markets is likely to increase, not decrease, systemic risk” (emphasis mine).
It’s important to parse Citigroup’s language a bit here. When they say “less regulated markets,” they actually mean a less regulated part of Citigroup. Swaps pushout didn’t require banks get rid of their swaps. Instead, it required the more exotic derivatives to by pushed into separately-capitalized subsidiaries...at the same firm. Why should Citigroup be concerned that less regulatory attention at another part of its own bank would increase systemic risk?
Let’s put aside the possibility that Citigroup is simply making whatever argument they need to make to justify gutting swaps pushout. Let’s instead give them the benefit of the doubt. If we take them at their word, what, exactly, are they saying?
Citigroup is making an important admission: if you under-police me, I will over-offend.
The only way that pushing derivatives activity into a “less regulated” part of Citigroup could increase systemic risk is if Citigroup is incapable of responsibly managing the risk of their own swaps without help from regulators. It seems that Citigroup’s own blog post indicts the firm of the very thing Warren accuses them: total unmanageability.
If Citigroup were truly concerned with the under-regulation of their non-FDIC-insured subsidiaries, they could easily write a bill and send it to Congress that would enhance regulation in that part of the bank. But of course, they haven’t.
Citigroup’s attempt to argue that swaps pushout would increase systemic risk also contradicts a point they make just two sentences later in the blog. Citigroup writes that the final language passed in the spending bill: “simply limits the swaps that are ‘pushed out’ to the riskiest type.” If Citigroup truly believes that its own non-FDIC insured subsidiaries are “less regulated,” how could they argue that it’s a good thing that only the “riskiest type” of swaps will now be pushed into them? Ed Skylar’s blog post is essentially at war with itself.
It is typically unwise to assume that a bank’s arguments are based on sound policy, rather than motivated by profit-seeking. So why did Citigroup want to keep most swaps inside of the FDIC account? I’m sure it won’t surprise you to learn that doing so keeps their costs lower, and also keeps an aggressive regulator at bay.
Allowing derivatives inside the FDIC-insured entity artificially lowers the banks’ cost of doing business. The FDIC subsidiaries typically have higher credit ratings, due to the market’s perception that they’re “Too Big To Fail.” Which is why Bank of America moved derivatives from its Merrill Lynch subsidiary to its FDIC-insured one in 2011, despite objections from the FDIC.
Citigroup may also have hoped to gut swaps pushout in order to minimize the role of the main derivatives regulator, the Commodity Futures Trading Commission (CFTC). Had swaps pushout been preserved, the CFTC would oversee the pushed out swaps, rather than the prudential regulators (the FDIC and the OCC) who currently oversee them. The CFTC — at least in the recent past — has been seen by many as an aggressive regulator, while the OCC has been asleep at the wheel when it comes to regulating derivatives. Contrary to Citigroup’s argument, pushing swaps out wouldn’t mean less regulation, it simply means different regulators.
As we move into 2015, with the Republican super-majority in Congress, we can expect more attempts to de-fang Dodd-Frank. Dodd-Frank itself was a compromise, but that hasn’t stopped Citigroup, despite its claim in the blog that they’re a “strong supporter of financial reform,” from chipping away at Dodd-Frank piece by piece. If past is prologue, we can expect Citigroup, and the rest of Wall Street, to continue to over-reach, and the Republican supermajority to let them. And it is the American public who will be stuck paying the price.