As state attorneys general take on a more muscular role in financial policy, enforcing consumer protection laws amid the deregulatory wave in Washington, they may soon add another item to their agenda: derivatives.

That is the hope of Michael Greenberger, a law professor at the University of Maryland, who recently published a paper on how big banks — such as JPMorgan Chase, Bank of America and Goldman Sachs — have taken advantage of loopholes in the regulation of derivatives under the Dodd-Frank Act.

With efforts to tighten derivatives regulations languishing in the nation’s capital, Greenberger called on state regulators and attorneys general to consider filing lawsuits in federal court that show the banks’ actions pose a financial threat to the public. Getting states involved, though, will be an uphill battle, he said.

“The biggest problem in getting the state attorneys general to do this is a lack of understanding,” Michael Greenberger, a professor at the University of Maryland’s Carey School of Law, said during a panel discussion in Manhattan on Tuesday. He cited the confusion that comes along with vague terms such as “naked credit default swaps” and “collateralized debt obligations.”

Thomas Hoenig (left) and Paul Volcker.
Seen this movie
Steps taken by big banks to deguarantee swaps units and sidestep Dodd-Frank show the danger of “too big to fail,” former FDIC Vice Chairman Thomas Hoenig (left) said Tuesday. Former Fed Chairman Paul Volcker echoed the call for closing loopholes in the derivatives rules. "I’ve seen it all before, over and over again," he said. Bloomberg News


In making his case, Greenberger pointed to risk-taking in the industry before the 2008 crisis and the subsequent federal bailout. He also argued that allowing big banks to sidestep post-crisis rules could have big financial implications for the public down the road.

“The United States taxpayer should never again have to be put in a position to bail out” big banks, Greenberger said.

Greenberger discussed the issue during an event sponsored by the nonprofit Institute for New Economic Thinking, alongside Paul Volcker, a former Federal Reserve chairman, and Thomas Hoenig, who recently retired as vice chairman of the Federal Deposit Insurance Corp.

Both former regulators supported Greenberger’s argument.

“I am 90 years old. I started in banking 70 years ago,” Volcker said, as he criticized the rising influence of financial lobbyists in the nation’s capital, and the urge among financial firms to roll back regulations when the economy is strong. “What strikes me is I’ve seen it all before, over and over again.”

At the heart of the issue in Greenberger’s paper is whether swaps dealers are designated as guaranteed, or financially backed, by their bank holding companies.

Dodd-Frank imposed a host of new rules for the derivatives market, requiring more disclosure, collateral and capital. In 2013, the Commodity Futures Trading Commission issued additional guidance on cross-border trades, saying that the new regulatory regime applied to all dealers that were guaranteed by a bank holding company.

But shortly thereafter, big U.S. banks found a way to evade the rules, according to Greenberger.

Following guidance from the International Swaps and Derivatives Association, the banks began to “deguarantee” their swaps subsidiaries in foreign markets. That in turn allowed banks to assign large portions of their trades — even those that were executed in New York — to their foreign subsidiaries, where the more onerous Dodd-Frank requirements did not apply.

In October 2016, the CFTC issued a proposed rule to close what Greenberger described as the “deguarantee loophole,” which would have extended Dodd-Frank requirements to foreign subsidiaries. But with the election of President Trump a month later, and Republican sweep of the legislative and executive branches, the commission has not moved forward on the matter.

“This can and should be fixed,” Greenberger said, describing it as a “plain violation of the plain language” of the extraterritorial provisions in Dodd-Frank.

Praising Greenberger’s research, Hoenig — who stepped down from the FDIC in late April — said the steps taken by big banks in the derivatives market show the danger of “too big to fail” and the working assumption among investors that big banks have the backing of the U.S. government if they collapse.

“ 'Too big to fail' is a huge subsidy,” Hoenig said. “It allows you to take on marginal risk beyond what you would otherwise take.”

The Financial Services Forum, a trade association representing large banking companies, defended the current system’s treatment of overseas activities, though it did not comment directly on Greenberger's paper.

U.S. regulators “have created a framework in which derivatives may be subject to the regulation of a host country when those rules are deemed comparable to U.S. rules,” Kevin Fromer, the Forum’s president and CEO, said in a statement emailed to American Banker. “This helps ensure a globally coordinated and efficient derivatives regulatory regime.”

During the event Tuesday — which was held at the Scandinavia House in Midtown — attendees discussed a host of other regulatory issues, including recent attempts to change the Volcker Rule, which bans banks from engaging in proprietary trading.

Volcker said he supports simplifying the rule that bears his name, but warned against the dangers of scaling it back in any significant way, citing the difficulty of writing “coherent” regulation at a time when the lobbying power of financial firms has significantly increased.

“If this is a simplification, great,” Volcker said.

Volcker also criticized attempts by trade associations in Washington to portray the rule as overly burdensome on the industry. At one point, he read aloud from a white paper issued by the American Bankers Association, which described the rule as impeding economic growth.

“ ’Rather than solving problems, the Volcker Rule has created problems,’ ” Volcker said, quoting the ABA. “ ’It has operated to impede the efficient operation of the financial system, drive banks away from providing services valued by their customers. It reduces competition in affected markets. It is an overall drag on the economy.’ ”

Volcker then pointed out that the economy is in the midst of an eight-year expansion, with unemployment at about 4%, its lowest rate in years. He also read aloud a pair of newspaper headlines, including one from the Financial Times on Monday, saying that U.S. banks are poised to pay out more than $170 billion in dividends and share buybacks.

“Little did I know that my little rule would be an overall drag on the economy,” he said.

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