The Battle Against Letting Wall Street Continue to Make a Killing on Derivatives

Protections for consumers and Wall Street's skullduggery are at stake in an obscure series of hearings going on in Congress right now.

Early in the morning, outside the House Financial Services Committee hearing room in the Rayburn office building last week, there were scruffy ex-homeless and other low-income folks, wearing their dreadlocks or sloppy jeans, mixed in with the pinstriped reps for the financial industry.

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They all seemed to be lining up to see what $223 million in financial lobbyingin the first six months of this year could buy in thwarting real reform on Capitol Hill. And they were hoping to get the few dozen of the public seats available inside the room, for a critical 10 a.m. hearing marking up a bill that was supposed to regulate the now-private market in complex "derivatives."

Those derivatives are nominally worth at least $450 trillion worldwide, with $555 billion in credit at risk in the U.S. banking industry. (Derivatives are forms of insurance or bets on underlying assets, such as now-toxic subprime mortgages, supposedly designed to manage risk.) No wonder Warren Buffett called them "financial weapons of mass destruction."

The derivatives bill is a cornerstone of the Obama administration's already-weakened reform plans that include a Consumer Financial Protection Agency facing a final vote this week.

On the Sunday talk shows, administration officials blastedWall Street executives for paying big bonuses. But their rhetoric on pay hasn't been matched by a unified, strong effort to rein in unregulated derivatives trading, Hill sources say, such as the toxic "credit default swaps" AIG used to help sink the economy.

And with $15 billion in profits from derivatives trading in the first half of 2009, according to Treasury Department figures, it's still a major source of huge bonuses for investment bankers.

But instead, the administration has put its shrinking political capital behind saving the CFPA this week from the assaults of Republicans, the Chamber of Commerceand community bankers who claim, as usual, that it means job-killing over-regulation.

And it seems to have paid off: A sweeping amendment proposed by centrist Democrat Rep. Melissa Bean,D-Ill., topreempt tougher state enforcement seems, surprisingly, likely to fail.

Yet the administration's purportedly high-priority agency legislation is already much weakeron protecting consumers from fraudulent or confusing loans than originally proposed. In addition, nothing in the current slate of embattled reform measures under consideration directly address either the foreclosure crisis or the ongoing credit shortages that are still costing jobs and homes. Their goal, in theory, is just to prevent future abuses.

And by the time the derivatives bill was finalized last Thursday, that legislation also bore little resemblance to the original White House proposalin June to regulate most derivatives on public exchanges designed to create transparency .

"The whole bill essentially has so many loopholes for every rule, it not only puts us back where we were in August 2008, but the banks have eliminated what little [derivatives] regulation existed, so we'll arguably be in worse shape than before Lehman Bros. failed," says Michael Greenberger, the former director of trading and marketing for the Commodity Futures Trading Commission and a University of Maryland law professor.

So what the hell happened to the White House's apparently good intentions to regulate derivatives, and what does it all say about the likely fate of financial reform after the worst economic crisis since the Great Depression?

And what about those poor people turning out to see the mark-up: Were they a nascent sign of a growing populist revolt against banking CEOs who took $17.5 trillionin federal bailouts, loans and guarantees with no strings attached after wrecking the world economy?

Meanwhile, the nation is still reeling from a credit crisis that has cost millions of jobs and homes.

In truth, the down-and-outers in the narrow hallway were there as placeholders in the line for the most elite lobbyists and Washington representatives of the even bigger, post-meltdown investment and commercial banks like Goldman Sachs and J.P Morgan Chase; such firms are now on track to pay their employees a record $140 billion this year.

So, the sleek, blond J.P Morgan lobbyist in a smart gray suit set off by a brightly colored scarf was able to saunter in shortly before the doors opened for the hearing to see just how many more loopholes could be added. (She declined to identify herself.)

Like the evicted family in Michael Moore's new film being hired by the bank to clean out their own home, the banking-industry lobbyists in Washington have at long last created the ultimate trickle-down effect from the bailouts: hiring the jobless( for $11 to $35 an hour) to hold their places in line to make sure there's no effective federal crackdown preventing more job-destroying speculation in credit default swapsand other derivatives.

(In fact, commercial banks earned over $5 billion by trading derivatives in the second quarter of this year, up 225 percentfrom the same period last year.)

How quickly Wall Street chooses to forget. Heather Booth, the director of theAmericans for Financial Reform coalition, observes: "Unregulated derivatives trading was a major cause of the economic crisis and loss of homes, jobs and retirement savings."

Before the vote, Booth, whose coalition represents 200 labor, community and advocacy groups, told me, "This is a David-and-Goliath fight. The biggest banks that created the circumstances that led to greater misery -- people losing their jobs and seeing their communities deteriorate -- those circumstances have not been changed and there needs to be real reform and structural change."

It's quite an uphill battle, but here is what's new this time in fighting for financial reform, Booth observes: "In the past, there never was anyone to push back on anything; now there is."

Indeed, a Hill staffer supporting financial reform told me, "What's been frustrating for Democrats is the lack of support we get from the progressive community. This year, with the Americans for Financial Reform coalition, we've had better grassroots response than we've seen for years [on these issues]."

Another Hill aide notes that the contacts on financial reform from hometown bankers and businessmen are now being matched by nonprofits and advocacy groups in the legislator's district, focused overwhelmingly on the financial protection agency.

But national consumer groups and labor leaders, including the AFL-CIO's Richard Trumka, have made their case for tough regulation of derivatives directly to Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee; Trumka even placed a phone call to Frank on the morning the mark-up began.

But the complex-yet-critical issue hasn't generated public interest, especially with so much effort focused on health reform: "It's not easy explaining the differences between [swaps] exchanges and clearinghouses," one activist complains about these arcane topics.

And Booth's group didn't even hold its first news conference until July, while the financial industry sabotaged earlier this year a series of House-passed reforms in the Senate.

These included bills to limit predatory lending and to force banks to let judges "cram down" renegotiated mortgages to keep people in their homes. In April, when public anger at the banking industry's role in the meltdown was far stronger, Sen. Dick Durbin, D-Ill., couldn't even get 60 votes to overcome a filibuster against his mortgage-foreclosure reform measure. He said of the banking industry: "Frankly, they own the place."

At first glance last week, that certainly seemed to be the case when House Financial Services Committee members ultimately passed a bill that apparently only sought to regulate banks trading in derivatives in proposed stock-market-type "exchanges."

Thanks to assorted business-friendly weasel words in the measure, the bill exempted almost everyoneelse from full-scale transparency and financial requirements, including potentially such major players in the "shadow market" as private equity and hedge funds. One key semantic loophole exempts any "end user" firm, such as a farm or manufacturer, that "hedges risk" by using a derivative, but critics say it's so vaguely worded it could allow non-banking financial firms like hedge funds to escape oversight, too.

Moreover, Greenberger and other critics note, the bill even lets the private sector's own "clearinghouses" that assess financial risk determine for themselves which deals should get regulated.

Amazingly enough, he says, it also flatly bars any state or federal agency from stopping risky deals before they take place. Would this new legislation prevent another AIG disaster? "No," Greenberger says bluntly.

In contrast, the House committee released a statement declaring: "The House Financial Services Committee today approved legislation that would, for the first time ever, require the comprehensive regulation of the over-the-counter (OTC) [or private ] derivatives marketplace."

Before this bill passed the committee, Booth and leading analysts say, about 90 percent of derivatives trading is concentrated in the hands of five major banks, with 95 percent of that business unregulated.

After the bill was voted out of committee, Booth and others, including the reform-minded Gary Gensler, chairman of the Commodity Futures Trading Commission, viewed the loophole-littered bill as making some progress, but generally gave it low marks.

Before the final vote, Gensler had challenged both the Treasury Department's version of the bill and the even-weaker draft prepared by Frank. Gensler had declared, "These exceptions could swallow up the regulation."

After the vote, he still wanted to make sure that it "covers the entire marketplace without exception." Up next: A fight to strengthen the bill when it's being considered by the House Agriculture Committee that oversees commodities -- and an expected floor fight to toughen it.

Booth explained in a statement, "The big Wall Street firms who make tens of billions of dollars from these trades -- and then left the taxpayers to clean up their mess -- want to continue with business as usual. … Real reform requires that virtually all derivatives trading be conducted on fully regulated, public, transparent exchanges that ensure capital adequacy."

The bill also does relatively little to crack down against fraud and speculation. Booth concluded, "Sadly, the House bill, in its current form, fails to meet these basic standards."

Despite all the criticismaimed at the bill, the political fight over the derivatives legislation, so far, has been more of a victory for progressives than it might seem at first glance.

Without a push-back from liberal Democrats on the committee over the last two weeks against weak draft versions, joined by progressive groups, critical newspaper editorials and columns and leaders of the SEC and the CFTC, the bill might have been even worse.

From June through mid-October, the administration's modest proposal to regulate all "standardized" derivatives on public exchanges got successively watered down. At first, Treasury Secretary Tim Geithner proposed a draft that was heavily influenced by banking-industry lobbyists, as reported by the New York Times in June, that used only private-sector clearinghouses and broadly exempted from regulation complicated "customized" derivatives written exclusively for an individual client -- just like the junk credit default swaps that AIG used to swindle investment banks. The White House version released later in June sought to broadly regulate most standard derivatives.

But by August, Geithner, who was exposed this month as primarily listening to a few major banking executivesas outside advisers, sent to the Hill a weaker version that created a variety of new loopholes to enable businesses to escape oversight.

It included potentially exempting virtually any non-bank that cooked up a derivative. Then Frank's proposal, aiming to keep centrist and Blue Dogs Democrats on board, added more loopholes that exempted even more businesses from regulation and originally didn't include the transparency of stock-market-type exchanges.

But after CFTC chairman Gensler attacked Frank's measure at a hearing in early October for potentially regulating no derivatives at all -- a "null set," he called it -- and the bad press and progressive lobbying mounted, Frank relented a bit.

Frank essentially conceded he had made too many compromises to placate centrists and Blue Dogs and said he preferred a stronger House Agriculture Committee bill over his own.

"As things stand now, I'd be more inclined to support the Ag bill," Frank told Washington Postcolumnist Harold Meyerson. One Hill staffer said, "The chairman's mark [version] missed the mark."

Yet by the first day of mark-up, Oct. 14, Frank introduced a new amendment that put what he called "major market participants" -- generally seen as banks -- in a regulated exchange. As he did so, Lisa Lindsley said,  "It's cosmetic." Lindsley, a lobbyist affiliated with AFR, is the deputy director of the United Food and Commercial Workers Capital Stewardship Office, which oversees union pension funds decimated by the Wall Street meltdown. A former Bear Stearns managing director-turned-idealist, she and an AFL-CIO lobbyist were one of the very few pro-consumer lobbyists at the mark-up watching the legislative sausage being made.

Because they didn't arrive early enough because of last-minute work, they were shunted upstairs to an overflow room filled with business lobbyists watching the hearings on closed-circuit television. They watched quietly, taking notes on amendments as Republicans used the mark-up to insist the financial industry didn't need new regulations, just better enforcement.

Lindsley had a mixed reaction to the final bill, passed on a nearly party-line vote of 43-26. While praising it for putting banks on an open exchange, she said, "It doesn't address the issue of trading between banks and non-banks."

But despite sniping, after the first day of mark-up, Frank told reporters he was pleased with the progress that had been made, and proclaimed, "We're close to the administration [original proposal]." He also claimed that most of the concerns of unions and liberal groups had now been addressed.

Hardly: Richard Trumka later declared, while vowing to work with Frank to improve the bill, "There is no logical reason to continue private and highly risky financial transaction that expose working families to the potential loss of jobs and home while also burdening taxpayers with the bills involved in such risky behavior."

The Republicans set the stage for this week's fight by denouncing the CFPA bill in strident terms borrowed from the health care debate. Rep. Tom Price, R-Ga., kept denouncing the CFPA with varying hyperbolic labels: "I call this the Restricting the American Dream and Financial Destruction Act," he said.

But as the mark-up went on, even though the Republicans lost on most of their amendments, they were shrewdly using the mark-up to lay the rhetorical groundwork for opposing the bill and giving a propaganda head start to Republican senators who'll later oppose these measures.

Democrats, with a few, brief exceptions, didn't bother to paint a dramatic picture of what was at stake in financial reform. And Frank and most Democrats bowed to pressure from community bankers and accepted an amendment that exempted 8,000 of the nation's 8,200 banks from the agency's oversight, leaving just the largest banks, with about 80 percent of commercial banking assets, examined annually for lending misdeeds.

Yet by moving toward passage of the consumer protection agency this week, even as there are still raging fights over proposed exemptions for auto dealers, insurance companies and credit unions, the ability to beat back the financial industry on any front is considered by some Washington observers as nothing short of a miracle.

The Washington Post even headlined a story on Monday: "Big Financial Firms Losing Power on Capitol Hill." And one knowledgeable House staffer told me, "After the TARP [bailout] program, nobody cares what the big banks have to say," while acknowledging the influence of district-based realtors and bankers on members.

Most progressive observersand public-interest groups wouldn't go that far, of course, in accepting that remarkably optimistic notion of a House of Representatives unswayed by powerhouse financial-related firms. After all, the Sunlight Foundationreported, 12 of the financial services committee members receive 35 percent or more of their donations from that one industry.

Booth has her own hopeful, but still realistic, view of the influences shaping Congress on financial reform.

"If there is a consumer protection agency, this will be the first recent engagement at this level of previously unaccountable power from the chamber and large corporations."

But her coalition still faces a major challenge on promoting reform: "It's much more daunting to make this all clear to the public."

Art Levine is a contributing editor of the Washington Monthly and a former fellow with the Progressive Policy Institute. He has also written for Mother Jones, the American Prospect, the New Republic, the Atlantic, Slate, Salon and numerous other publications. He is the author of 2005's PPI report, "Parity-Plus: A Third Way Approach to Fix America's Mental Health System," and he is currently researching a book on mental health issues. Levine also posts commentary at Art Levine Confidential