High & Low Finance: New Dodd-Frank Rules Muddled by Congress That Wants It Both Ways

Both.

As the rules get written for Dodd-Frank, the financial reform law that Congress enacted last year, the essential contradictions in the law are being left to regulatory agencies to sort out. Whatever they do, you can depend on legislators to say the regulators are ignoring Congressional intent — or at least the intent of one faction or the other.

Consider the Volcker Rule, named for its chief proponent, Paul A. Volcker, a former chairman of the Federal Reserve. It prohibits banks from engaging in proprietary trading.

If that sounds straightforward to you, you may not have read the rule, or the new 298-page effort by regulators to figure out how to apply it. That effort produced howls of anguish from those who liked the idea of the rule, and similar reactions from those who hated it.

Some might say the equal disdain shows that the regulators are trying to steer a middle course. It might be more accurate to say they were given an impossible task.

A similar fight is going on over “skin in the game” rules for mortgage risk retention. The law says that lenders who sell mortgages to investors should retain some of the risk.

That seemed wise after the bad loans fiasco that helped bring down both the banking system and the economy.

But the law also says that those rules should not apply to especially safe mortgage loans, called qualified residential mortgages in the law. It is up to the regulators to figure out which is which.

In each case, those who want tougher rules point to the risks that came home all too clearly in 2008 and 2009. Banks and some of their customers say the economy, and bank profits, will be hurt if rules bite too deeply.

The Volcker Rule, as enacted, “generally prohibits banking entities from engaging in proprietary trading,” as the regulators stated in their opus this week. But the law goes on to provide exemptions for such things as “trading on behalf of customers,” “risk-mitigating hedging activity” and “underwriting and market-making activities.”

And there are exceptions to the exceptions. As Mary Schapiro, the chairwoman of the Securities and Exchange Commission, explained, “These otherwise permitted activities are not permitted, however, if they involve material conflicts of interest, high-risk assets or trading strategies, or if they threaten the safety and soundness of banking institutions or U.S. financial stability.”

In other words, you can’t tell the difference between a prohibited activity and an allowed one just by looking at what a bank did; you have to instead divine its purpose. Then, even if the purpose is worthy, you have to decide if the risk is too high.

The logic behind the Volcker Rule is that banks are special, and should not be able to do some of the things other market players are free to do. Banks are special because they benefit from government-insured deposits. Big banks are even more special because if they gamble and lose, it may be the government that ends up with the loss, via a bailout.

But banks also provide a lot of services beyond just taking deposits and making loans. Customers want those services to continue to be available.

The rules proposal this week does not claim to be complete. The document lists 383 questions for those commenting on the proposal to consider in recommending changes. Some of those questions have multiple queries. Here’s one example:

“Question 19. Is the exchange of variation margin as a potential indicator of short-term trading in derivative or commodity futures transactions appropriate for the definition of trading account? How would this impact such transactions or the manner by which banking entities conduct such transactions? For instance, would banking entities seek to avoid the use of variation margin to avoid this rule? What are the costs and benefits of referring to the exchange of variation margin to determine if positions should be included in a banking entity’s trading account? Please explain.”

Article source: http://feeds.nytimes.com/click.phdo?i=1c08f8cd8921d04bdbd55a2cb9400449