Simon Johnson surprisingly discovers a "radical idea" in the financial reform bill

Flawed Financial Bill Contains Huge Surprise: Simon Johnson

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And yet there is one item that is more than a surprise -- in fact, its presence in the final bill is quite stunning.

This is what is known as the Kanjorski Amendment, after Congressman Paul Kanjorski, chairman of the House Subcommittee on Capital Markets, part of the House Financial Services Committee.

Big Shift

In essence, Kanjorski proposed that a group of 10 federal regulators be given the explicit power to break up big financial firms when they pose systemic risk. Not only that, the wording of the bill makes it clear that these regulators now face the expectation that they will use these powers.

This is a big shift in responsibility, away from the Federal Reserve, which implicitly had all kinds of emergency powers but would never have taken such action.

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The Kanjorski Amendment wasn’t a surprise. It is an entirely reasonable reaction to the too-dangerous-to-fail experience of 2008-2009. The surprise here is that the bank lobbyists weren’t able to get it taken out or entirely watered down. The supermajority decision-making at the level of the risk council might seem like a weakening from the original Kanjorski proposal, but it also helped keep political support for what is, at its heart, a very radical idea.

What it Does

We talked about this amendment briefly here, and here is the text. So what does this amendment do?

- First off, this amendment makes it clear that bank holding companies follow capital rules that are at least as tough as those imposed on banks. This is the essence of the shadow banking problem: if you want to act like a bank you have to be regulated like a bank.

- This amendment also makes clear that if you are engaged in riskier activities than a bank, you must hold more capital. Examples it gives of risky activities are “(i) significant volumes of activity in derivatives, securitized products purchased and sold, financial guarantees purchased and sold, securities borrowing and lending, and repurchase agreements and reverse repurchase agreements.” You know, the things that caused the last crisis and could cause it all over again.

- This amendment also implies, in conjunction with the last paragraph, that banks will need to hold more capital when it comes to scope of businesses. The more high-risk business lines that a bank has, including ones that we can’t even think of yet, the more capital it has to hold. It tells the regulators that, when they aren’t certain, to require more capital.

- It also establishes “(A) the minimum ratios of tier 1 capital to average total assets, as established by the appropriate Federal banking agencies to apply to insured depository institutions under the prompt corrective action regulations…regardless of total consolidated asset size or foreign financial exposure.”

No more capital loopholes! No more playing BS games where a firm creates a trust and does financial engineering alchemy to pretend that debt is equity. Serious, quality capital is required for our largest and most systemically risky banks.

This is probably the real fight. When it comes to increasing capital under the Dodd Bill you can practically hear the banks say: “Yes we’ll hold more capital as long as massive amount of risky debt turned into ‘safe’ equity through the shenanigans of our financial engineers can count as that capital.” Do we need to do that all over again?

Enough people think these points are implied in Section II of the bill, but the ability to have discretion on this point is something the regulators are fighting tooth and nail over. And here’s something fascinating: for all the talk about how Basel III and “international agreements” will fix our bank capital problems, the US is fighting this over there too. Check out the bold above; having serious quality capital for our banks is a major disagreement between the US and the Europeans, with the US wanting weaker requirements, and if their hands are tied here then they’ll be tied over there where they could possibly win this.

They fought the Collins amendment for quality of bank capital, fought leverage requirements like a 15-to-1 cap, fought prefunding the resolution mechanism, fought Section 716 spinning out swap desks, removed foreign exchange swaps and introduced end user exemption from derivative language between the Obama white paper and the House Bill, believed they could have gotten the SAFE Banking Amendment to break up the banks but didn’t try, pushed against the full Audit the Fed and encouraged the Scott Brown deal.

<...>What is worth noting is that they always end up leaving their fingerprints on the side of less structural reform and in favor of the status quo on Wall Street. These are some of the many ideas that progressives brought to the table, and there’s a documentable trail of each one of them being opposed and fought against by the administration. This is not to say that the administration is against reform. But it is to say that the problem I see is that they think what we had was a crisis where regulators didn’t have enough powers, not that the financial sector in 2007 was too dangerous and too risky. They did push hard for the CFPA, and I am thankful for that.