(Repeats story that ran on June 16 with no changes to headline
* Fed rule on bank affiliates being tightened-Senate aide
* Lawmakers struggle over swap affiliate status-Reed
* Regional Fed bank president Bullard backs Lincoln plan
By Kevin Drawbaugh and Charles Abbott
WASHINGTON, June 16 Democrats were working on
Wednesday to bolster a plan that would force big banks to spin
off their swap dealing desks, with backers of Senator Blanche
Lincoln's controversial proposal aiming to push forward.
In the face of opposition from Wall Street, the Senate
Banking Committee was seeking to tighten Federal Reserve rules
to address concerns some lawmakers have about isolating swap
dealing units from the banks that spin them off, an aide said.
The Fed's "arm's length" rules are supposed to limit risks
posed to a bank from transactions between it and its
affiliates. The rules have been set aside in years past and are
a weakness in Lincoln's plan, according to some aides.
Strengthening them would draw more support from Democrats,
many of whom want something like Lincoln's plan to be in the
sweeping Wall Street reform legislation that is being finalized
by a Senate-House of Representatives conference committee.
The Lincoln proposal is "moving along and it's moving along
in the right direction," Democratic Senator Jack Reed told
Reuters in an interview after a meeting of the committee.
"The critical issue now is, if you're going to move this
derivatives trading, is it all the way out of the holding
company, or is it within an affiliate? We're still struggling
with that," said Reed, a conference committee member.
Swaps are derivative financial contracts that let their
users hedge against risks of changing interest rates, exchange
rates or, in the case of credit default swaps, or CDS, the
likelihood of a borrower defaulting on its debts.
The $615-trillion market for derivatives traded
off-exchange is dominated by a handful of big Wall Street
banks, including Goldman Sachs (GS.N), JPMorgan Chase (JPM.N),
Morgan Stanley (MS.N), Citigroup (C.N) and Bank of America
Lincoln has proposed that these banks and others be forced
to separate swap dealing and banking. The idea is to reduce the
likelihood of more bailouts, like those seen in the 2008-2009
crisis, by preventing swap markets from jeopardizing the safety
of banks backed by taxpayers.
When she first unveiled her proposal earlier this year, it
was widely interpreted as calling for banks to completely
separate themselves from their swap trading desks.
On Monday, she issued a "clarification" that said banks
could spin off their swap dealing into separately capitalized
subsidiaries still within their holding companies.
She also said banks themselves could continue to be swap
market participants, using off-exchange derivatives to hedge
their own risks and offering the same services to customers.
However, Senate aides said the most important part of the
"clarification" was that spun-off dealing desks could remain in
the bank holding company. That raised questions about how
isolated they would truly be from the bank, the aides said.
"JPMorgan is a $2-trillion bank with an $80-trillion
derivatives exchange out back," said one aide.
"I don't care whether that's sitting on top of the bank or
sitting on top of some bank-holding company sub, if it goes
ka-boom, you're still going to hit the bank."
The Fed's arm's length rules, known as 23A and 23B, are
supposed to protect banks from affiliates' problems.
"But historically the 23A and 23B firewalls drop every time
a crisis hits," the aide said.
Firming up those rules looks likely to be key to the
Lincoln's plans prospects.
NOT FAR ENOUGH-PROFESSOR
"The only problem with Senator Lincoln's derivatives
amendment is that it does not go far enough to drive toxic
derivatives out of the bank holding company temple entirely,"
said Boston University Law School Professor Cornelius Hurley.
"By lodging this casino activity in bank holding company
affiliates, she runs the risk of the Fed doing in the next
crisis exactly what it has done in this one, namely waiving the
rigid rules that are supposed to separate banks from their
holding company affiliates," Hurley said.
In a related development, a spokesperson for St. Louis
Federal Reserve Bank President James Bullard said on Wednesday
that he supports Lincoln's plan.
Fed Chairman Ben Bernanke has expressed concern with the
proposal. So have many moderate House Democrats and Democratic
Representative Barney Frank, conference committee chairman.
When the committee finishes its work, likely by the end of
the month, the Lincoln plan or something like it will probably
be in the final bill, said Michael Konczal, a fellow at the
Roosevelt Institute, a policy think-tank.
He said it was unclear how much better banks would be
protected from risks if swap dealing desks were spun off into
affiliates still housed inside holding companies.
"At the end of the day, we won't know until we're in the
middle of the next crisis," Konczal said.
(For a Factbox on new tweaks to Lincoln's plan, double-click
(Additional reporting by Mark Felsenthal in New York; Editing
by Jan Dahinten)