Wall Street Always Gets Its Way

(Before It's News)

TND Guest Contributor: Paul-Martin Foss |

Citigroup Center in New York City

Congress recently passed a 1600+ page omnibus spending bill to fund government operations for the remainder of the fiscal year. As has been the norm with these types of bills, they afford a great opportunity for all sorts of mischievous provisions to be slipped in without notice. After all, who is going to take the time and effort to read a 1600-page bill, especially when you’re only given a day or two to look over it? One of the more egregious provisions that was slipped in this time around was a section that was purported to offer relief to banks by repealing the so-called “push-out” rule enacted in the Dodd-Frank bill in 2010. This relief provision was originally introduced in the 113th Congress as H.R. 992, the Swaps Regulatory Improvement Act. It passed the House on October 30, 2013 by a vote of292-122, but was never taken up in the Senate. But the big banks wanted this provision enacted into law, and so it was stuck into the omnibus spending bill and now will be signed into law.

Analysis and text of the bill is after the jump. Because of the numerous subsections, it’s difficult to format text like this properly in WordPress, so it might be a little difficult to follow all the legislative text below. The provision eliminating the push-out rule can be found in Division E, Title VI, Section 630 of the omnibus bill, on page 615 of this PDF. The section of US Code that is being modified can be found here.

Let’s start with the analysis first before we lose everyone with legislative text. The push-out provision basically states that any “swap entity” as defined in the section cannot receive federal assistance if they engage in swap activity. This also applies to insured depository institutions (banks) that engage in swaps outside of certain narrow swap activity directly related to their depository activities. Federal assistance is defined as participation in Federal Reserve discount window lending, certain Federal Reserve credit facilities, or loans or guarantees through FDIC. What is important to keep in mind is that this provision of law does not prohibit swap activity, it merely states that if you engage in swap activity and don’t meet the exemptions of this section, or if you don’t spin your swap activity off into a separate entity (push-out), you can’t receive assistance (i.e. bailouts) from the Federal Reserve or FDIC. In other words, no taxpayer subsidies for companies who engage in certain swap activity.

What the language put into the omnibus did is significantly weaken those provisions of law. While there was already an exclusion in the push-out rule for some activities of FDIC-insured banks, this new language expanded that loophole to include uninsured agencies or branches of foreign banks. So foreign banks engaging in swap activities in the US are now able to receive bailouts from the Fed or from FDIC, which they previously were not able to get. It also expands the types of swap activities that FDIC-insured banks are able to engage in, including swaps based on asset-backed securities. Remember the AAA-rated mortgage-backed securities that ended up being completely worthless? Well, banks can now engage in swap activity with these types of asset-backed securities and have it backed up by government guarantees. As has been widely reported in the past, the language of H.R. 992 that has now been passed in the omnibus was largely written by Wall Street bank lobbyists.

FDIC insurance for bank deposits is already a subsidy to banks, allowing them to use funds deposited by consumers to make risky loans. If those loans go bad, the FDIC swoops in to clean things up and the taxpayers ultimately pick up the tab. And access to the Federal Reserve’s discount window and credit facilities is another subsidy, enabling banks to receive loans cheaper than they would otherwise get on the market. These government guarantees lead to a riskier, less stable banking system, because bankers always assume that the government is going to be there to bail them out.

In an ideal banking system, there would be no government subsidies and bailouts to the banking sector. Any deposit insurance schemes would have to be market-based, and any financial assistance to banks would have to be made based on their fundamental soundness. A free market banking system would encourage sound, safe banking because there would be no bailouts. If the banks screw up, they’re out of business. In order to move towards that ideal, the current subsidies that the banking system receives in the form of FDIC guarantees or access to Federal Reserve lending facilities need to be done away with, piecemeal if need be. Bills such as H.R. 992 and the language passed in the omnibus are going in exactly the opposite direction, expanding the government safety net and ensuring that “Too Big to Fail” is going to be with us for a long time to come.

***Legislative text is below.***

For those who want to go through it, here’s the text that was stuck into the omnibus.

SEC. 630. Section 716 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (15 U.S.C. 8305) is amended—
(1) in subsection (b)—
(A) in paragraph (2)(B), by striking “insured depository institution” and inserting “covered depository institution”; and
(B) by adding at the end the following:
“(3) COVERED DEPOSITORY INSTITUTION.—
The term ‘covered depository institution’ means—
“(A) an insured depository institution, as that term is defined in section 3 of the Federal Deposit Insurance Act (12 U.S.C. 1813); and
“(B) a United States uninsured branch or agency of a foreign bank.”;
(2) in subsection (c)—
(A) in the heading for such subsection, by striking “INSURED” and inserting “COVERED”;
(B) by striking “an insured” and inserting “a covered”;
(C) by striking “such insured” and inserting “such covered”; and
(D) by striking “or savings and loan holding company” and inserting “savings and loan holding company, or foreign banking organization (as such term is defined under Regulation K of the Board of Governors of the Federal Reserve System (12 CFR 211.21(o)))”;
(3) by amending subsection (d) to read as follows:
“(d) ONLY BONA FIDE HEDGING AND TRADITIONAL BANK ACTIVITIES PERMITTED.—
“(1) IN GENERAL.—The prohibition in subsection (a) shall not apply to any covered depository institution that limits its swap and security-based swap activities to the following:
“(A) HEDGING AND OTHER SIMILAR RISK MITIGATION ACTIVITIES.— Hedging and other similar risk mitigating activities directly related to the covered depository institution’s activities.
“(B) NON-STRUCTURED FINANCE SWAP ACTIVITIES.— Acting as a swaps entity for swaps or security-based swaps other than a structured finance swap.
“(C) CERTAIN STRUCTURED FINANCE SWAP ACTIVITIES.— Acting as a swaps entity for swaps or security-based swaps that are structured finance swaps, if—
“(i) such structured finance swaps are undertaken for hedging or risk management purposes; or
“(ii) each asset-backed security underlying such structured finance swaps is of a credit quality and of a type or category with respect to which the prudential regulators have jointly adopted rules authorizing swap or security-based swap activity by covered depository institutions.
“(2) DEFINITIONS.— For purposes of this subsection:
“(A) STRUCTURED FINANCE SWAP.— The term ‘structured finance swap’ means a swap or security-based swap based on an asset-backed security (or group or index primarily comprised of asset-backed securities).
“(B) ASSET-BACKED SECURITY.— The term ‘asset-backed security’ has the meaning given such term under section 3(a) of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)).”;
(4) in subsection (e), by striking “an insured” and inserting “a covered”; and
(5) in subsection (f)—
(A) by striking “an insured depository” and inserting “a covered depository”; and
(B) by striking “the insured depository” each place such term appears and inserting “the covered depository”.

Here’s how the section being modified currently reads. N.B. This is not the entirety of the section, as the subsections run from (a) through (m). These are just the most relevant subsections to the discussion, and the subsections being modified by the omnibus language.

§8305. Prohibition against Federal Government bailouts of swaps entities

(a) Prohibition on Federal assistance

Notwithstanding any other provision of law (including regulations), no Federal assistance may be provided to any swaps entity with respect to any swap, security-based swap, or other activity of the swaps entity.

(b) Definitions

In this section:

(1) Federal assistance
The term “Federal assistance” means the use of any advances from any Federal Reserve credit facility or discount window that is not part of a program or facility with broad-based eligibility under section 343(3)(A) of title 12, Federal Deposit Insurance Corporation insurance or guarantees for the purpose of-
(A) making any loan to, or purchasing any stock, equity interest, or debt obligation of, any swaps entity;
(B) purchasing the assets of any swaps entity;
(C) guaranteeing any loan or debt issuance of any swaps entity; or
(D) entering into any assistance arrangement (including tax breaks), loss sharing, or profit sharing with any swaps entity.

(2) Swaps entity
(A) In general
The term “swaps entity” means any swap dealer, security-based swap dealer, major swap participant, major security-based swap participant, that is registered under-
(i) the Commodity Exchange Act (7 U.S.C. 1 et seq.); or
(ii) the Securities Exchange Act of 1934 (15 U.S.C. 78a et seq.).

(B) Exclusion
The term “swaps entity” does not include any major swap participant or major security-based swap participant that is an insured depository institution.

(c) Affiliates of insured depository institutions
The prohibition on Federal assistance contained in subsection (a) does not apply to and shall not prevent an insured depository institution from having or establishing an affiliate which is a swaps entity, as long as such insured depository institution is part of a bank holding company, or savings and loan holding company, that is supervised by the Federal Reserve and such swaps entity affiliate complies with sections 371c and 371c–1 of title 12 and such other requirements as the Commodity Futures Trading Commission or the Securities Exchange Commission, as appropriate, and the Board of Governors of the Federal Reserve System, may determine to be necessary and appropriate.

(d) Only bona fide hedging and traditional bank activities permitted
The prohibition in subsection (a) shall apply to any insured depository institution unless the insured depository institution limits its swap or security-based swap activities to:
(1) Hedging and other similar risk mitigating activities directly related to the insured depository institution’s activities.
(2) Acting as a swaps entity for swaps or security-based swaps involving rates or reference assets that are permissible for investment by a national bank under the paragraph designated as “Seventh.” of section 24 of title 12, other than as described in paragraph (3).

(3) Limitation on credit default swaps
Acting as a swaps entity for credit default swaps, including swaps or security-based swaps referencing the credit risk of asset-backed securities as defined in section 3(a)(77) 1 of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(77)) (as amended by this Act) shall not be considered a bank permissible activity for purposes of subsection (d)(2) unless such swaps or security-based swaps are cleared by a derivatives clearing organization (as such term is defined in section la of the Commodity Exchange Act (7 U.S.C. la)) or a clearing agency (as such term is defined in section 3 of the Securities Exchange Act (15 U.S.C. 78c)) that is registered, or exempt from registration, as a derivatives clearing organization under the Commodity Exchange Act or as a clearing agency under the Securities Exchange Act, respectively.

(e) Existing swaps and security-based swaps
The prohibition in subsection (a) shall only apply to swaps or security-based swaps entered into by an insured depository institution after the end of the transition period described in subsection (f).

(f) Transition period
To the extent an insured depository institution qualifies as a “swaps entity” and would be subject to the Federal assistance prohibition in subsection (a), the appropriate Federal banking agency, after consulting with and considering the views of the Commodity Futures Trading Commission or the Securities Exchange Commission, as appropriate, shall permit the insured depository institution up to 24 months to divest the swaps entity or cease the activities that require registration as a swaps entity. In establishing the appropriate transition period to effect such divestiture or cessation of activities, which may include making the swaps entity an affiliate of the insured depository institution, the appropriate Federal banking agency shall take into account and make written findings regarding the potential impact of such divestiture or cessation of activities on the insured depository institution’s (1) mortgage lending, (2) small business lending, (3) job creation, and (4) capital formation versus the potential negative impact on insured depositors and the Deposit Insurance Fund of the Federal Deposit Insurance Corporation. The appropriate Federal banking agency may consider such other factors as may be appropriate. The appropriate Federal banking agency may place such conditions on the insured depository institution’s divestiture or ceasing of activities of the swaps entity as it deems necessary and appropriate. The transition period under this subsection may be extended by the appropriate Federal banking agency, after consultation with the Commodity Futures Trading Commission and the Securities and Exchange Commission, for a period of up to 1 additional year.

And here’s how it will read after being amended. Changes made by the omnibus bill are designated by strikethroughs and italics.

§8305. Prohibition against Federal Government bailouts of swaps entities

(a) Prohibition on Federal assistance

Notwithstanding any other provision of law (including regulations), no Federal assistance may be provided to any swaps entity with respect to any swap, security-based swap, or other activity of the swaps entity.

(b) Definitions

In this section:

(1) Federal assistance
The term “Federal assistance” means the use of any advances from any Federal Reserve credit facility or discount window that is not part of a program or facility with broad-based eligibility under section 343(3)(A) of title 12, Federal Deposit Insurance Corporation insurance or guarantees for the purpose of-
(A) making any loan to, or purchasing any stock, equity interest, or debt obligation of, any swaps entity;
(B) purchasing the assets of any swaps entity;
(C) guaranteeing any loan or debt issuance of any swaps entity; or
(D) entering into any assistance arrangement (including tax breaks), loss sharing, or profit sharing with any swaps entity.

(2) Swaps entity
(A) In general
The term “swaps entity” means any swap dealer, security-based swap dealer, major swap participant, major security-based swap participant, that is registered under-
(i) the Commodity Exchange Act (7 U.S.C. 1 et seq.); or
(ii) the Securities Exchange Act of 1934 (15 U.S.C. 78a et seq.).

(B) Exclusion
The term “swaps entity” does not include any major swap participant or major security-based swap participant that is an insured depository institution covered depository institution.

(3) Covered depository institution
The term “covered depository institution” means-
(A) an insured depository institution, as that term is defined in section 3 of the Federal Deposit Insurance Act (12 U.S.C. 1813); and
(B) a United States uninsured branch or agency of a foreign bank.

(c) Affiliates of insured covered depository institutions
The prohibition on Federal assistance contained in subsection (a) does not apply to and shall not prevent an insured a covered depository institution from having or establishing an affiliate which is a swaps entity, as long as such insured such covered depository institution is part of a bank holding company, or savings and loan holding company savings and loan company, or foreign banking organization (as such term is defined under Regulation K of the Board of Governors of the Federal Reserve System (12 CFR 211.21(o))), that is supervised by the Federal Reserve and such swaps entity affiliate complies with sections 371c and 371c–1 of title 12 and such other requirements as the Commodity Futures Trading Commission or the Securities Exchange Commission, as appropriate, and the Board of Governors of the Federal Reserve System, may determine to be necessary and appropriate.

(d) Only bona fide hedging and traditional bank activities permitted.-
(1) In General.- The prohibition in subsection (a) shall not apply to any insured covered depository institution unless the insured depository institution that limits its swap or and security-based swap activities to the following:
(1) (A) Hedging and other similar risk mitigation activities.- Hedging and other similar risk mitigating activities directly related to the insured covered depository institution’s activities.
(2) (B) Non-structured finance swap activities.- Acting as a swaps entity for swaps or security-based swaps other than a structured finance swap. involving rates or reference assets that are permissible for investment by a national bank under the paragraph designated as “Seventh.” of section 24 of title 12, other than as described in paragraph (3).
(C) Certain structured finance swap activities.- Acting as a swaps entity for swaps or security-based swaps that are structured finance swaps, if-
(i) such structured finance swaps are undertaken for hedging or risk management purposes; or
(ii) each asset-backed security underlying such structured finance swaps is of a credit quality and of a type or category with respect to which the prudential regulators have jointly adopted rules authorizing swap or security-based swap activity by covered depository institutions.
(2) Definitions.- For purposes of this subsection:
(A) Structured finance swap.- The term “structured finance swap” means a swap or security-based swap based on an asset-backed security (or group or index primarily comprised of asset-backed securities).
(B) Asset-backed security.- The term “asset-backed security” has the meaning given such term under section 3(a) of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)).

(3) Limitation on credit default swaps
Acting as a swaps entity for credit default swaps, including swaps or security-based swaps referencing the credit risk of asset-backed securities as defined in section 3(a)(77) 1 of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(77)) (as amended by this Act) shall not be considered a bank permissible activity for purposes of subsection (d)(2) unless such swaps or security-based swaps are cleared by a derivatives clearing organization (as such term is defined in section la of the Commodity Exchange Act (7 U.S.C. la)) or a clearing agency (as such term is defined in section 3 of the Securities Exchange Act (15 U.S.C. 78c)) that is registered, or exempt from registration, as a derivatives clearing organization under the Commodity Exchange Act or as a clearing agency under the Securities Exchange Act, respectively.

(e) Existing swaps and security-based swaps
The prohibition in subsection (a) shall only apply to swaps or security-based swaps entered into byan insured a covered depository institution after the end of the transition period described in subsection (f).

(f) Transition period
To the extent an insured depository a covered depository institution qualifies as a “swaps entity” and would be subject to the Federal assistance prohibition in subsection (a), the appropriate Federal banking agency, after consulting with and considering the views of the Commodity Futures Trading Commission or the Securities Exchange Commission, as appropriate, shall permit the insured depository the covered depository institution up to 24 months to divest the swaps entity or cease the activities that require registration as a swaps entity. In establishing the appropriate transition period to effect such divestiture or cessation of activities, which may include making the swaps entity an affiliate of the insured depository the covered depository institution, the appropriate Federal banking agency shall take into account and make written findings regarding the potential impact of such divestiture or cessation of activities on the insured depository the covered depository institution’s (1) mortgage lending, (2) small business lending, (3) job creation, and (4) capital formation versus the potential negative impact on insured depositors and the Deposit Insurance Fund of the Federal Deposit Insurance Corporation. The appropriate Federal banking agency may consider such other factors as may be appropriate. The appropriate Federal banking agency may place such conditions on the insured depository the covered depositoryinstitution’s divestiture or ceasing of activities of the swaps entity as it deems necessary and appropriate. The transition period under this subsection may be extended by the appropriate Federal banking agency, after consultation with the Commodity Futures Trading Commission and the Securities and Exchange Commission, for a period of up to 1 additional year.

# # # #

About  Paul-Martin Foss:

Paul-Martin Foss is the founder, President, and Executive Director of the Carl Menger Center for the Study of Money and Banking, an Arlington, VA-based think tank dedicated to educating the American people on the importance of sound money and sound banking.

Prior to founding the Menger Center, Mr. Foss worked in the U.S. House of Representatives for seven years, including six years as Congressman Ron Paul’s legislative assistant for monetary policy and financial services, and one year as Deputy Legislative Director for Congressman Thomas Massie.

As Congressman Paul’s legislative assistant, he assisted the Congressman in his duties as Chairman of the Subcommittee on Domestic Monetary Policy by helping to develop hearing topics, agendas, and briefing Congressmen and their staffs on monetary policy topics. Mr. Foss also was responsible for the management of Dr. Paul’s monetary policy and financial services legislation, including the “Audit the Fed” and “End the Fed” bills, and was co-editor of Ron Paul’s Monetary Policy Anthology, a multi-thousand page compilation of hearing transcripts, lecture transcripts, and other documents related to Dr. Paul’s chairmanship.

Mr. Foss received his Bachelor’s degree from The University of the South (Sewanee), and Master’s degrees from the London School of Economics and Georgetown University’s Edmund A. Walsh School of Foreign Service.

This article appeared on the Carl Menger Center for the Study of Money and Banking and is reprinted with permission, “Creative Commons 4.0.”

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