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'Act of Congress' Details Sausage-Making That Was Dodd-Frank Law

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Kaiser’s book begins with a Sept. 18, 2008, meeting of congressional leaders, Treasury Secretary Paulson and Federal Reserve Chairman Bernanke.

The difficulties of restricting proprietary trading are made clear in the book’s account of the appearance of Goldman Sachs’ CEO before the Senate Homeland Security and Governmental Affairs Permanent Subcommittee on Investigations. “The evidence shows that Goldman repeatedly put its own interests and profits ahead of the interests of its clients and our communities,” according to the panel’s chairman, Michigan Democrat Carl Levin. At issue was whether Goldman sold products to clients and then bet the firm’s own money that these products would lose value, according to Kaiser. Goldman CEO Lloyd Blankfein responded that its proprietary trading account was irrelevant to market-making, and likely not of concern to its clients. One person’s proprietary trading, restricted by the Volcker rule, is another’s market-making.

Kaiser’s book does a good job of demonstrating the risks of regulatory arbitrage, where firms shop around for the weakest regulator. Insurance giant AIG, for instance, would not have been able to operate in Europe without a consolidated regulator, and it found an easy way around this. It purchased a savings and loan to come under the supervision of the weak Office of Thrift Supervision, thus allowing it to work with derivatives in London. Some of its derivatives, credit default swaps (which are essentially insurance on subprime mortgages) were a major cause of the market crunch. The OTS was abolished by Dodd-Frank.

Regulatory arbitrage continues to be an issue, and federal financial regulators are currently deciding whether to exempt foreign firms from U.S. regulation over certain derivatives, if they face adequate foreign supervision.

“Act of Congress” describes how AIG was a major headache for lawmakers. It received a bailout of more than $170 million, making it into what Kaiser called a ward of the state. The country then learned of AIG’s plans to pay its employees $165 million in bonuses. Kaiser noted that around the same time, the company reported a $100 billion loss for 2008, the largest ever by an American company.

Many in Congress were appalled by the Wall Street bonuses. The book tells how the administration argued that it was powerless to stop these bonuses, and how they were needed to keep quality staff. Where these quality employees would have gone if they had quit over not getting bonuses remains a mystery. Although not in the book, it is worth noting that the head of General Motors Co. was fired by the U.S. government after its bailout, while many Wall Street executives did just fine.

Whether banks could trade in derivatives was another hot topic during Senate consideration of the legislation. Blanche Lincoln, an Arkansas Democrat who chaired the Agriculture Committee and lost her seat in November 2010, urged pushing derivatives trading out of banks and into affiliates. The idea posed significant unintended consequences, according to bank regulators. A bank that sold its swaps operation might need to use swaps to hedge risky assets on its balance sheet. This hedging could, under the Lincoln proposal, deny the bank access to FDIC insurance. In the end, Congress approved a weaker proposal.

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