"Volcker rule" at issue as reform bill nears finale

Paul Volcker, chairman of the newly formed Economic Recovery Advisory Board, attends a speech by U.S. President Barack Obama about Wall Street reforms at Cooper Union in New York April 22, 2010.

WASHINGTON (Reuters) - As Congress got to work crafting a final Wall Street reform bill on Tuesday, new tensions surfaced over the proposed "Volcker rule" that aims to curb risky trading and investing by banks.

White House economic adviser Paul Volcker, in a letter obtained by Reuters, said he firmly opposes exemptions to his rule being sought by banks that say they make only small investments in private equity and hedge funds.

At the same time, some Senate Democrats were moving to toughen the Volcker rule by reducing the latitude given to regulators in implementing it once it becomes law -- a prospect now widely seen as all but certain, likely within weeks.

Conflict over the rule -- which threatens the profits of banking giants such as Goldman Sachs and Morgan Stanley -- came as a congressional conference committee prepared for its first meeting on merging House and Senate reform measures into the biggest bank regulation overhaul since the 1930s.

After days of behind-the-scenes talks among conferees, the committee will hold its first public meeting on Thursday, with the goal of completing its work by June 26, Representative Barney Frank, the committee chairman, said on Tuesday.

House of Representatives Speaker Nancy Pelosi will appoint Democratic members from that chamber to the joint Senate-House committee on Wednesday, Frank told reporters.

Frank and other conference committee leaders will have the difficult job of balancing Democrats' desire for a hard-hitting bill with the need to retain some support from Republicans who have generally sided with Wall Street in resisting changes.

The completed House-Senate package must win passage in each chamber before it can be sent to Obama to be signed.

FRANK, DODD VOW OPEN PROCESS

Frank said conferees will aim to work for six to eight days between Thursday and June 26. He and his Senate counterpart, Democrat Christopher Dodd, said they would make committee sessions as open as possible.

Using the Senate-passed legislation as a starting point, conference members will have to propose changes a day before they are voted on, in an effort to avoid the secret deal-making that has marked past conference committees, Frank said.

"We certainly have no reason to try to keep the public out," Frank said. "We've benefited from its presence, he added," noting that public attention so far has had the effect of making the legislation tougher on Wall Street.

Dodd said the Senate conferees, who have already been appointed, will hold an initial meeting on Wednesday.

The Volcker rule was first proposed in January by Volcker and President Barack Obama, stunning capital markets.

It would curb proprietary trading by banks for their own accounts unrelated to customers' needs; bar them from sponsoring hedge funds and private equity funds; and limit their future growth through a new cap on market share.

The Senate bill, approved last month, endorsed the rule, but subjected it to a two-year study by regulators that critics said left the door open to watering it down later.

The Volcker rule is not in the House bill, but the bill has language that would let regulators bar proprietary trading at institutions that threaten financial stability.

Senate aides said large banks are pressing for "de minimis" exemptions to the Volcker rule that would let them invest in outside funds for marketing or relationship purposes.

VOLCKER "ABSOLUTELY" OPPOSES EXEMPTIONS

"I absolutely oppose any such modification" of the Senate bill, Volcker said in his May 17 letter sent to Dodd.

"Allowing a bank to invest in a speculative fund goes against the very intent of the (Senate) bill as we seek to define those activities that are worthy of government protection," he said in the letter.

The fight over the Volcker rule was unfolding in tandem with efforts by banks to kill another proposed measure that would force them to spin off their swap-trading desks.

Swaps are derivative contracts that allow wagering on the direction of interest rates or the likelihood of a borrower defaulting on its debt, known as a credit default swap.

Credit default swaps were blamed in the 2007-2009 financial crisis that hammered economies worldwide, triggering taxpayer bailouts and a global wave of financial reform initiatives.

The swap-desk measure from Democratic Senator Blanche Lincoln could be dropped if the Volcker rule is toughened, some sources said, but the interplay between the two was unclear.

"We should correct the derivatives language independent of the Volcker rule and then try to get the Volcker rule right, which is also a complex issue. I don't think the two should be linked," Republican Senator Judd Gregg told Reuters Insider.

A key factor will be the outcome of Lincoln's difficult primary election race back home in Arkansas on Tuesday.

Analysts have said for weeks that her swap desk "push-out" measure would likely be dropped, something that would be even more likely if she loses in the primary.

MERKLEY: TOUGHEN VOLCKER RULE

Senator Jeff Merkley told Reuters on Tuesday that the Volcker rule is crucial to reform and should be toughened.

He and Senator Carl Levin, both Democrats, want to give regulators less discretion in implementing it. Merkley said he and Levin would meet on Tuesday with Volcker "to discuss the conference committee and how we're going to get this done."

Volcker, in a May 19 letter to Merkley and Levin, expressed support for their proposal, saying it would "clarify and enhance the proprietary trading restrictions" in the bill.

Levin told reporters on Tuesday that he was not linking the measure he and Merkley support to the Lincoln provision. "We're not arguing that it's one or the other," Levin said.

Banking industry analysts estimated last month that the sweeping financial reforms then being debated in Congress, taken together, could reduce big banks' profits in a range of 12 to 35 percent, depending on the institution.

Other banks whose profits could be hit by the Volcker rule, include Citigroup, JPMorgan Chase and Bank of America.

On another front, Dodd said discussions were under way about a possible transition period that would help banks comply with new capital standards being proposed in the Senate bill under an amendment by Republican Senator Susan Collins.

"I don't know if it's been resolved yet. We're working very closely with Senator Collins," Dodd said.

Both the House and Senate bills call for higher capital requirements on banks and financial firms as they get bigger and assume more risk. Neither bill has much detail, however, largely leaving that up to regulators -- with one difference.

The Collins amendment would make bank holding companies adhere to the same capital standards as bank subsidiaries. It would also bar bank holding companies from counting certain hybrid securities in meeting a key measure of strength.

(Additional reporting by Caren Bohan, Rachelle Younglai, Thomas Ferraro and Charles Abbott; Editing by Leslie Adler)