The fight over the Volcker rule is shifting in Wall Street’s favor.
After a four-month lobbying blitz led by firms including Goldman Sachs Group Inc. (GS), JPMorgan Chase & Co. (JPM) and Credit Suisse Group AG (CSGN), U.S. regulators and lawmakers are signaling they’re receptive to delaying and revising their plan to stop banks from making speculative trades on their own accounts.
Representative Barney Frank, a Massachusetts Democrat and co-author of the 2010 law mandating the ban, urged regulators last week to simplify their first draft, while a bipartisan group of senators proposed pushing back its effective date.
Banking executives have long seen the rule as one of the most threatening parts of the Dodd-Frank regulatory overhaul, an assault on a lucrative line of business that comes branded with a name, that of ex-Federal Reserve Chairman Paul Volcker, garnering worldwide respect. Compliance and capital costs alone could reach $1 billion annually, the U.S. Office of the Comptroller of the Currency has said.
To make their case in Washington, banks and trade associations have been pressing a coordinated campaign to get regulators from five federal agencies to scale back the draft of the proprietary-trading rule issued in October, according to public and internal documents and interviews. They recruited money managers, industrial companies, municipal officials and foreign governments to their side.
“The regulators are under a lot of pressure,” said Marcus Stanley, policy director of Americans for Financial Reform, an advocacy coalition that filed a comment letter urging that the draft rule be strengthened rather than watered down.
Stanley, a former congressional aide, said that his side has at most a couple of dozen people working the agencies and Congress. Meantime, he said, hundreds of banking representatives are enlisting their customers by warning that the rule’s fallout will be higher costs and less-liquid markets.
In one typical encounter at a public event late last year, JPMorgan Chief Executive Officer Jamie Dimon encouraged BlackRock Inc. (BLK) CEO Laurence D. Fink to weigh in, said two people familiar with the conversation who like others interviewed for this story spoke on condition of anonymity because the meetings were private. They didn’t give further details on the event.
Some banks recommended consultants and law firms, including Davis Polk & Wardwell LLP and Sullivan & Cromwell LLP (1147L), to help clients write letters arguing that the proposed language defines proprietary trading too broadly. Partnering with trade associations, the banks also commissioned studies, tested messages with focus groups, distributed talking points and set up a phone hotline for Capitol Hill staffers.
While it will be months before the results of the onslaught can be fully measured, the financial industry has seen encouraging signs. That success demonstrates that four years after Wall Street helped cause the worst economic downturn since the Great Depression and prompted a $700 billion taxpayer bailout, its lobby is regaining its power to blunt or deflect efforts to rein in the banks.
Federal Reserve Chairman Ben S. Bernanke publicly acknowledged that the measure won’t be finished by the July 21 deadline imposed by Congress. Testifying before the Senate Banking Committee March 22, Fed Governor Daniel Tarullo noted the issues raised by lawmakers and bankers “have led a lot of people to think we probably need to provide some clarification.”
‘Work to Do’
At a House Financial Services panel on Jan. 18, agency heads including Securities and Exchange Commission Chairman Mary Schapiro spoke of the challenge they faced writing a rule to end risky practices without crimping the flow of capital. Treasury Secretary Timothy F. Geithner said in a Dallas speech this month that there was “absolutely some work to do” on the provision.
The Volcker rule will have a direct impact only on the largest Wall Street firms with extensive trading operations. The Government Accountability Office estimated last year that standalone proprietary trading groups at the six biggest banks generated $15.6 billion in revenue from 2006 to 2010.
JPMorgan spokesman Jennifer Zuccarelli, Credit Suisse (CS) spokesman Jack Grone and Goldman Sachs spokesman David Wells declined to comment.
While Volcker himself has lobbied for preserving the intent of the rule, he hasn’t chosen to make a public fight with the banks and has said he agrees the proposal as written is too complex. His historic initiative to prevent a repeat of the 2008 credit crisis is likely to take effect in a diluted form.
Proponents of the rule say tough restrictions are the best way to ensure that the banks don’t use privileges like federal deposit insurance to subsidize their own profit-making and make risky trades of the kind that contributed to the 2008 credit crisis.
U.S. Senator Jeff Merkley, the Oregon Democrat who with Senator Carl Levin, a Michigan Democrat, put the rule in Dodd- Frank, said there’s no evidence it would choke off liquidity in the markets. “The banks are using every strategy they possibly can” to “confuse the issue,” Merkley said.
Bartlett Naylor, who works on financial policy at the Washington-based advocacy group Public Citizen, said his small band of Volcker supporters is highlighting the recent New York Times op-ed article by ex-Goldman Sachs derivatives salesman Greg Smith to show the need for a strong rule. The article, which Goldman Sachs said it disagrees with, accuses the firm of making trades against its clients’ interests to boost profits.
“It comes from an insider who declares something that everyone knows or certainly has a suspicion of,” said Naylor. “We have talked to everybody about it, and nobody we’re talking to hasn’t already heard about it.”
Camden Fine, the president of the Independent Community Bankers of America, said his group rejected calls from the large banks to join the Volcker opposition. Wall Street’s arguments that the rule would raise costs and hurt the markets are the ones it’s used for years to oppose regulation, Fine added.
“It’s the same song, different verse,” he said. “A bunch of these guys have just sort of forgotten the last four years.”
From the moment President Barack Obama raised the idea of the Volcker rule two years ago, bankers opposed it, saying that it wouldn’t cut risk and would hinder their ability to manage clients’ money. They grew more alarmed when regulators published the 298-page draft Oct. 11 because it seemed to ban much of what is called market-making: buying and holding securities to facilitate client trades when there’s no ready counterparty.
The rule would bar banks from making proprietary trades, which means trading for their own accounts and taking sizeable positions in stocks, bonds or derivatives that could amount to large bets on the direction of the market. It also limits the amount they can invest in hedge and private equity funds.
Financial interests didn’t expect to outright kill the rule as long as Democrats control the Senate and the White House. Most major firms, preparing for the ban, have already shut down the desks they used to trade for their own accounts.
Instead they set out to reshape the plan, contending that the constraints will hurt much of the finance world, not just a handful of large banks. They want regulators to expand the definition of market making and narrow what is considered proprietary, arguing that they should be allowed to maintain an inventory of securities to facilitate client trades and help them raise capital by issuing debt.
Banks perceived an opening when the five agencies — the Fed, the OCC, SEC, Federal Deposit Insurance Corp. and Commodity Futures Trading Commission — asked for feedback on some 1,300 questions.
Tainted by Bailouts
Knowing that they were tainted by bailouts and vulnerable to charges they were trying to preserve excessive profits, the banks looked for other firms to help press the argument.
That’s what made Robert Auwaerter such a valuable ally.
Auwaerter, who manages $650 billion as head of the fixed income group at mutual fund company Vanguard Group Inc., was in attendance on a day in early February, shortly after the Super Bowl, when Credit Suisse invited Democratic congressmen to its New York office for a presentation on the Volcker rule.
Almost all Republican lawmakers already opposed Dodd-Frank. Banks would have more sway with regulators if they could show bipartisanship. They turned to a group of House members known as the New Democrats for their centrist and pro-business leanings.
Credit Suisse hosted three members from the caucus — Representatives Joe Crowley of New York, Jim Himes of Connecticut and John Carney of Delaware — along with Auwaerter and officials from firms including Prudential Financial Inc. (PRU), MetLife Inc. (MET) and Western Asset Management Co.
The session lasted about 90 minutes and “was a great dialogue,” Auwaerter, who led the discussion, said in an interview. “They were really receptive to our comments.”
Crowley pushed back at one point, telling the group that he’d recently marched in a Lunar New Year parade in Queens with Thomas DiNapoli, the New York State Comptroller who oversees a state retirement fund of about $140 billion. Why wasn’t DiNapoli complaining about Volcker?
The asset managers told Crowley they have a closer view of how the markets work than the pension funds that hire them. The proposed rule, they said, would slow bond trading, making it harder for them to execute their strategies. They predicted that would mean lower returns for funds like DiNapoli’s, as well as for 401(k) plans and individual investors.
Less than two weeks after the Credit Suisse visit, 26 New Democrats signed a letter to regulators noting that “millions of public school teachers, police officers and private employees depend on liquid markets and low transaction costs” to retire with “dignity and ease.”
Asked about the connection between the letter and the meeting, Crowley said in a statement that the lawmakers also heard from “many of those on the front lines” including teachers, firefighters, state governments and businesses who said they could be hurt by the rule. It was clear, he said, that “more conversations need to be had to ensure any final regulation is done right.”
DiNapoli declined through a spokeswoman to comment.
Shortly after the Credit Suisse meeting, Auwaerter traveled with other asset managers to Washington and gave similar presentations at the Fed, Treasury and SEC. He said Credit Suisse and other banks didn’t have to twist his arm.
“I am advocating positions that make sense for my investors,” Auwaerter said. “Certainly not shilling for the banks.”
Bankers also were keen to recruit BlackRock, the world’s largest money manager. Besides Dimon’s talk with Fink, BlackRock Vice Chairman Kendrick Wilson III heard from ex-colleagues at Goldman Sachs, two other people said. A Credit Suisse delegation went to BlackRock’s offices to make their pitch.
‘Weaken’ the System
When BlackRock sent comments to the federal agencies last month, it delivered just the kind of warning the banks hoped for. The rule as written “will limit U.S. banks’ competitiveness and ultimately weaken the very system it was designed to protect,” BlackRock wrote in its Feb. 13 letter.
The firm, which manages about $3.5 trillion, said it already was planning to file a Volcker letter before it heard from any banks. “BlackRock has an active public policy effort and will comment on issues that we feel are important to our clients,” spokesman Brian Beades said.
Lawmakers and lobbyists said that another influential critique came from AllianceBernstein Holding LP (AB) CEO Peter Kraus. On Nov. 16, several months before comments were due, Kraus sent a letter to regulators saying the rule would have a “devastating effect” on bond markets.
“I do think we’ve had at least some measure of success,” said Kraus, whose firm manages about $424 billion. “We wrote the letter under my signature early so that we would hopefully get people to start to take notice of it.”
Goldman Sachs officials were among representatives from several banks that had raised the Volcker matter with their contacts at AllianceBernstein, according to two people briefed on the talks. Kraus, who was co-head of Goldman Sachs’ investment management division before he took the helm at AllianceBernstein in 2008, said he decided to weigh in after hearing from clients who were concerned about the rule. Kraus didn’t speak directly with anyone at his old firm before writing the letter, said another person familiar with the matter.
As they plotted strategy, the banks also made contact with the U.S. Chamber of Commerce, the nation’s biggest business lobby that has generally been a strong opponent of Dodd-Frank. The chamber worked to develop a fix-Volcker message that would resonate with members of Congress and the public, and then helped assemble a coalition of almost 30 companies and associations including Caterpillar Inc. (CAT), DuPont Co. (DD), Macy’s Inc. (M), Safeway Inc. (SWY) and Boeing Co.
The chamber convened focus groups of politically sophisticated Washingtonians, whose initial reactions weren’t encouraging. While skeptical of regulators, most participants didn’t know exactly what “market-making” was and didn’t like the sound of it, according to David Hirschmann, president of the chamber’s Center for Capital Markets Competitiveness. They also reacted positively to the name Volcker.
The focus groups, said Hirschmann, showed that the chamber and its allies would need to painstakingly explain how banks handle trades and how companies raise capital and how that benefits Main Street. There was “no magic, silver bullet” to describe the rule’s problems, he said.
Volcker ‘For Dummies’
Other trade groups also lobbied on Capitol Hill. The Financial Services Forum and the American Bankers (2919Q) Association circulated a 14-page presentation on the rule’s consequences to aides on the House and Senate banking panels. Sort of a “Volcker Rule for Dummies,” it compared Wall Street market- making to how Amazon.com Inc. manages inventory for the Christmas rush.
Eventually, some Senate Democrats weighed in with regulators. Tom Carper and Chris Coons of Delaware, along with Mark Warner of Virginia, joined three Republicans in signing a Feb. 16 letter listing concerns over the proposal’s costs, impact on liquidity and foreign reach. Democrats Kay Hagan of North Carolina, Kirsten Gillibrand of New York and Michael Bennet of Colorado, sent their own letters, asking regulators to take care with the market-making exemption.
Outside U.S. borders, Wall Street opened another front. Central banks heard from firms including Credit Suisse, Deutsche Bank AG (DB) and HSBC Holdings Plc (HSBA) in Europe, Mitsubishi UFJ Financial Group Inc. (8306) in Japan and the Royal Bank of Canada that the Volcker rule threatened to reach outside U.S. jurisdiction, while also placing their sovereign debt at a disadvantage because U.S. Treasury bonds would be exempt from the rule.
Economic aides from France, Germany, Canada, Japan and other countries gathered in January at the U.K.’s Washington embassy to discuss Volcker and coordinate a response, a person with direct knowledge of the meeting said. By the end of February, central bankers or regulators from each of the countries — and sometimes both — formally voiced concern to U.S. counterparts.
The proposal raises “a number of concerns that would appear to have implications that are disproportionate in light of the objective that the rule is trying to achieve,” Michel Barnier, the European Union’s financial services commissioner, wrote in a Feb. 8 letter to regulators.
Not all of Wall Street’s targets were receptive to the arguments.
Several large banks asked the California Public Employees’ Retirement System, the largest U.S. public pension fund, to file comments highlighting Volcker’s negative effects, according to two people familiar with the matter.
A Calpers portfolio manager, Louis Zahorak, attended meetings with Vanguard’s Auwaerter and other members of the Credit Roundtable and Fixed Income Forum at the Fed, Treasury and SEC, where the participants pressed for changes, according to the agencies’ posted schedules.
Yet when the $235.8 billion California fund wrote its February letter to regulators, it backed the rule while recognizing it would boost expenses and make securities markets less liquid.
“We acknowledge that the systemic protections come at a price,” Calpers wrote, adding that it was “an acceptable cost for reducing risk in the financial system.”
Calpers spokesman Wayne Davis declined to comment.
The counterweight to the Wall Street push has come mainly from Merkley, Levin and a few public interest groups. The senators filed a 54-page comment letter saying that the Volcker rule “is intended to provide a 21st century version of the Glass-Steagall Act” that separated investment and commercial banking in the 1930s and “served our economy — and financial system — so well.”
Volcker himself met with the Fed’s Tarrulo and SEC chief Schapiro, agency documents show. In his formal comment letter, Volcker said he was “impressed” by the agencies’ success so far “in reaching agreement on the preliminary rule and by your confidence that the regulation can and will be successfully implemented.”
As staff members at the five agencies weigh the more than 17,000 public comments, the next question is whether the rule can be completed by the end of the year.
Stephen Myrow, of ACG Analytics Inc., a Washington investment research firm, said that at the very least the banks have bought some time by focusing attention on the rule’s potential drawbacks. “Now the regulators are left trying to ascertain how real those concerns are,” Myrow said.
Naylor, of Public Citizen, said it’s no surprise that the banking industry would work so hard to dilute a rule that restricts an activity as profitable as proprietary trading.
“It can be the source of enormous bonuses for bankers and therein is the argument for the fierceness of their fight,” Naylor said.
By Robert Schmidt and Phil Mattingl
Courtesy of Bloomberg News