Nothing 'Almost as Good as Glass-Steagall' Is Left

December 13, 2014

The "Cromnibus" or "poison pill" spending bill repealed Section 716 of the Dodd-Frank Act. This section was the whittled-down nub of what originally was the 2010 (Sen. Blanche) Lincoln Amendment, which was a requirement that Wall Street banks do ALL of their derivatives trading in separate subsidiaries, separately capitalized. So it began as something "almost as good as Glass-Steagall."

Glass-Steagall did not, and would not allow commercial banks in the Federal Reserve System to conduct derivatives trading, except for — if they were permitted "wealth management" — futures and options trading for their clients and with their clients' money. It would not allow them any connection — neither by cross-management, capitalization, control, nor even by lending or credit support — to securities or derivatives dealers.

The Lincoln Amendment passed in the Senate bill after a long fight, was opposed by the Obama White House and Barney Frank, and removed in conference. Section 716 was substituted, and then it was claimed that it plus the Volcker Rule were "just as good as Glass-Steagall."

Under Section 716, the banks, which were doing ALL their derivatives trading in FDIC-insured units — including Morgan Stanley and Goldman Sachs, which had been granted holding company status, founded dummy "commercial bank" units, and moved their derivatives books there — would have to "push out" commodity derivatives and uncleared credit default swaps (CDS) to separate units without FDIC insurance. This is a total of about $35-40 trillion of the overall $700-plus trillion in derivatives exposure (using the Bank for International Settlements' version). The commodity derivatives are $25-30 trillion, and Goldman, Morgan Stanley, and Citibank have the lion's share of exposure. Of the uncleared CDS, it's JPMorgan Chase all the way.

MIT economist and banking expert Simon Johnson clarified on Dec. 11: "Under Section 716, interest rate swaps, foreign exchange derivatives, and cleared credit derivatives can remain on the balance sheet of the insured bank. This is almost all derivatives. And hedging of risks by banks using derivatives is most definitely allowed" by Section 716 [emphasis added].

So, under this latest "as good as Glass-Steagall," 90-plus percent of all derivatives exposure has remained with banks insured by FDIC; i.e., in a crisis, insured by taxpayer funds. And so are, still, all the money-market mutual funds run by the banks and the shadow banks.

Now Wall Street has made clear that even this was not enough taxpayer bailout insurance for them. Why? The $35-40 trillion in derivatives which the late Section 716 supposedly excluded from bail-out, were the riskiest derivatives exposure the big banks have. And $5-10 trillion of that exposure is to energy derivatives, which face blowout in the immediate future due to the sudden oil price collapse. These will now be bailed out.

Unless, now, the real Glass-Steagall Act appears.