CLE Materials for Panel #1 - George Washington University Law ...

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WILMARTH 4/1/2011 1:11 PM 1034 OREGON LAW REVIEW [Vol. 89, 951 with the result that “the largest banks’ [derivatives] operations are largely left intact.” 363 The requirement that banks must clear their trades of CDS to be exempt from the Lincoln Amendment is potentially significant, in view of the new clearing requirements set forth in other provisions of Dodd-Frank. 364 However, there is no clearing requirement for other derivatives (e.g., interest and currency rate swaps) that reference assets permissible for investment by national banks (“bank-eligible” derivatives). Consequently, banks may continue to trade and deal in OTC derivatives (except for CDS) without any interference from the Lincoln Amendment, as long as those derivatives are bank-eligible. 365 As discussed above, all “proprietary trading” by banks in derivatives must also comply with the Volcker Rule as implemented by regulators. 366 2. Banks Controlled by Financial Holding Companies Should Operate as “Narrow Banks” so That They Cannot Transfer Their Federal Safety Net Subsidies to Their Nonbank Affiliates A fundamental purpose of both the Volcker Rule and the Lincoln Amendment is to prevent LCFIs from using the federal safety net subsidies to support their speculative activities in the capital markets. As enacted, however, both provisions have numerous gaps and exemptions that undermine their stated purpose. 367 Given the greatly weakened versions of both statutes, Paul Volcker was undoubtedly 363 Keoun & Kopecki, supra note 339 (quoting analyst Nancy Bush). 364 Title VII of Dodd-Frank establishes comprehensive clearing, reporting, and margin requirements for a wide range of derivatives. See S. REP.NO. 111-176, at 29–35, 92–101 (2010) (discussing Title VII as proposed in the Senate committee bill); Alison Vekshin & Phil Mattingly, Lawmakers Reach Compromise on Finanical Regulation, BLOOMBERG (June 25, 2010), http://www.bloomberg.com/news/2010-06-25/lawmakers-reach -compromise-on-financial-regulation.html (summarizing Title VII as approved by the House-Senate conference committee). A detailed analysis of Title VII is beyond the scope of this Article. Major financial institutions have already engaged in heavy lobbying to influence the adoption of regulations that will implement Title VII. See Asjylyn Loder & Phil Mattingly, Wall Street Lobbyists Besiege CFTC to Shape Derivatives Rules, BLOOMBERG (Oct. 13, 2010), http://www.bloomberg.com/news/2010-10-14/wall-street -lobbyists-besiege-cftc-to-influence-regulations-on-derivatives.html. 365 Dodd-Frank Act § 716(d)(2); see also Andrew Leonard, How the World Works: The Dodd-Frank Bank Reform Bill: A Deeply Flawed Success, SALON.COM, June 25, 2010. 366 See supra Part V.D.1.b. 367 See supra Part IV.D.1.b & 1.c.
WILMARTH 4/1/2011 1:11 PM 2011] The Dodd-Frank Act 1035 correct when he said that the Dodd-Frank legislation “went from what is best to what could be passed.” 368 As shown below, the most effective way to prevent the spread of federal safety net subsidies from banks to their affiliates involved in the capital markets would be to create a two-tiered structure of bank regulation and deposit insurance. The first tier of “traditional” banking organizations would provide a relatively broad range of banking-related services, but those organizations would not be allowed to engage (or affiliate with firms that are engaged) in securities underwriting or dealing, insurance underwriting, or derivatives dealing or trading. In contrast, the second tier of “narrow banks” could affiliate with “nontraditional” financial conglomerates engaged in capital markets activities (except for private equity investments). However, as described below, “narrow banks” would be prohibited from making any extensions of credit or other transfers of funds to their nonbank affiliates, with the exception of lawful dividends paid to their parent holding companies. The “narrow bank” approach provides the most feasible approach for ensuring that banks cannot transfer their safety net subsidies to affiliated companies engaged in speculative activities in the capital markets, and it is therefore consistent with the objectives of both the Volcker Rule and the Lincoln Amendment. 369 a. The First Tier of Traditional Banking Organizations Under my proposal, the first tier of regulated banking firms would be “traditional” banking organizations that limit their activities (including the activities of all holding company affiliates) to lines of business that satisfy the “closely related to banking” test under 368 Uchitelle, supra note 3 (quoting Mr. Volcker). 369 The following discussion of my proposal for a two-tiered structure of bank regulation and deposit insurance is adapted from Wilmarth, supra note 6, at 764–79. I am indebted to Robert Litan for a number of the concepts incorporated in my two-tiered proposal. See generally ROBERT E. LITAN, WHAT SHOULD BANKS DO? 164–89 (1987). For additional works favoring the use of “narrow banks” to achieve a strict separation between banking institutions and affiliates engaged in capital markets operations, see, Emilios Avgouleas, The Reform of ‘Too Big-to-Fail’ Bank: A New Regulatory Model for the Institutional Separation of ‘Casino’ from ‘Utility’ Banking, Feb. 14, 2010, available at http://ssrn.com/abstract=1552970; Kay, supra note 144, at 39–92; Ronnie J. Phillips & Alessandro Roselli, How to Avoid the Next Taxpayer Bailout of the Financial System: The Narrow Banking Proposal (Networks Fin. Inst., Pol’y Brief 2009-PB-05, 2009), available at http://ssrn.com/abstract_id=1459065.
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