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CQ TODAY ONLINE NEWS
May 16, 2012 – 11:17 p.m.

Morgan Loss Slows House Attack on Dodd-Frank

By Ben Weyl, CQ Staff

The ripple impact of the $2 billion trading loss at J.P. Morgan Chase & Co. is starting to hit Congress.

House Republicans have halted, at least for now, their assault on the Dodd-Frank financial regulatory overhaul. Senate Democrats, meanwhile, are seizing on the headlines to bolster their case for confirmation of top financial regulatory nominees who have remained stalled in the chamber. And the debate over implementation of the 2010 law has been thrown into sharp relief, with regulators under new pressure to finalize strict rules that might have prevented the blowup.

The most visible result so far is to come with votes Thursday on nominations to the Federal Reserve Board.

President Obama’s nominees, Jerome H. Powell and Jeremy C. Stein, have languished for weeks over the objections of Sen. David Vitter, R-La., and it seemed doubtful Senate Democrats intended to use precious time on the Senate floor for the nominees. But Senate Majority Leader Harry Reid this week filed cloture on the nominees and now will bring the nominations to the floor for direct votes on Thursday, with 60 votes need for confirmation.

In comments to reporters, Reid directly tied the J.P. Morgan trades to the need to confirm the Fed nominees and finalize the rule barring proprietary trading by banks.

“They were betting like you would do at the craps table in Las Vegas, and they bet the wrong way,” said the Nevada Democrat. “The Fed, who’s responsible for drawing up those rules, they should have been done a long time ago.”

House Action Braking

J.P. Morgan’s loss also is creating a braking effect in the House, where the GOP has sought to dismantle the law (PL 111-203), which was enacted in the wake of the 2008 financial industry meltdown. The House Agriculture Committee was set to continue those efforts Thursday with a markup of legislation to roll back derivatives regulation. But lawmakers did not want to be seen as watering down regulations against the backdrop of J.P. Morgan’s news, and the markup was abruptly postponed.

Agriculture Chairman Frank D. Lucas, R-Okla., blamed Washington’s “tendency to overreact,” and he insisted the bills under consideration were unrelated to the sort of trading that hit J.P. Morgan. “However, this committee will take the time to gather all relevant information before we proceed to ensure there are no unintended consequences of the legislation that would encourage recklessness in our financial institutions,” Lucas said.

In fact, at least one bill scheduled for a vote may have directly affected the bank’s actions. The measure (HR 3283), sponsored by Connecticut Democrat Jim Himes, would exempt from the law’s clearing and margin requirements derivatives trades that subsidiaries of U.S. banks make overseas.

J.P. Morgan’s costly derivatives trades were made by its London office.

The Himes bill had strong GOP support and modest backing from Democrats. Some critics, including Rep. Barney Frank, D-Mass., had signaled they were open to supporting the measure if it were amended. Despite signs that a compromise was in the works, the bill’s chances have now dimmed considerably.

Democratic leaders in the Senate have so far shown no inclination to take up legislation to change Dodd-Frank, and their appetite to do so now appears even lower. Instead, they moved this week to bolster regulatory efforts by filling the vacancies at the Fed.

Morgan Loss Slows House Attack on Dodd-Frank

The Fed is one of the lead agencies implementing the regulatory overhaul, including a new ban on proprietary trading by banks, often called the Volcker rule, which might have prohibited J.P. Morgan’s ill-fated trades.

Named for former Federal Reserve Chairman Paul A. Volcker, who proposed it, the rule is supposed to take effect in July. However, regulators have struggled to finalize the complex restrictions and appear unlikely to do so before the statutory deadline. Democrats have blamed the slow pace, in part, on the sluggish speed in filling key regulatory positions.

The House Financial Services and the Senate Banking, Housing and Urban Affairs committees have both announced plans to investigate J.P. Morgan’s trades in the coming weeks, and top federal regulators are sure to be on the hot seat.

“There’s no doubt that this week’s news of J.P. Morgan’s trading losses has raised significant questions about the supervision of risk within an institution,” Rep. Shelley Moore Capito, R-W.Va., said Wednesday at a Financial Services subcommittee hearing. She said that although it appears “the firm had sufficient capital to absorb the significant loss, one of the questions I would ask is, would a less capitalized institution survive a similar loss?”

Also up for debate is whether the Volcker rule as proposed by regulators would have prevented J.P. Morgan from making the trades. But it is unclear if regulators will now change course even if Democrats argue the rule should be toughened.

The law bars federally insured depository institutions from seeking to profit by trading in securities with their own money. If the bank is backed by taxpayer dollars, Volcker rule supporters argue, it should not be making such risky trades.

Hedging on Volcker Rule

Some exemptions were included. For example, banks can make trades designed to hedge certain risks. J.P. Morgan Chief Executive Jamie Dimon, a vocal critic of the Volcker rule, has said the trades involved in his bank’s losses were hedges that would have been permitted under the restrictions.

Earlier this week, Sen. Bob Corker, R-Tenn., said staff in the Office of the Comptroller of the Currency told him the trades would not have been prohibited under the regulators’ proposal. Later, the agency, which supervises federally chartered banks and is helping to craft the rule, stepped back from some of those statements.

Democratic Sens. Jeff Merkley of Oregon and Carl Levin of Michigan, the legislative authors of the Volcker rule, have said the current proposal likely would have allowed the trades to go forward. For that reason, they charge, the draft rule is far too loose and deviates from the law’s congressional intent.

Until now, the banking industry appeared to be largely winning its argument that the Volcker rule needed to be flexible. Although that case likely has lost some momentum, analysts are not certain regulators are ready to change course.

“The predictable reaction was that the J.P. Morgan news would lead to tougher enforcement of the Volcker rules by the regulators. That may be the case, but reports of J.P. Morgan’s trade are not conclusive, in our view, as to whether the trade would have been permitted under Volcker or not,” Brian Gardner, a banking industry analyst with Keefe Bruyette & Woods, wrote in a research note.

“This underscores the difficulty in interpreting the Volcker rules and leaves it unclear how much tougher regulators will be enforcing Volcker compared [with] how they would have enforced the rules absent the J.P. Morgan announcement.”

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