This report was updated Friday at 10:25 a.m. ET and on Monday at 2:45 p.m. ET (see below).
After nearly 20 hours over two final days filled with backroom dealing, House and Senate negotiators struck a grand compromise to merge the two chambers' competing bills to reform the nation's financial system in a party-line vote. But the long hours of closed-door meetings also appear to have fulfilled Wall Street's greatest wish: Many of the measures that offered the greatest chances to fundamentally reshape how the Street conducts business have been struck out, weakened, or rendered irrelevant.
Democrats unanimously supported passage; Republicans unanimously voted against it, warning that the bill doesn't accomplish its central objective: ending the perception that some financial firms are too big to fail.
The two most high-profile provisions were the last items to be considered. Neither emerged intact. One would have forced banks to stop trading financial instruments with their own capital and give up their stakes in hedge funds and private equity funds, named after its original proponent, former Federal Reserve Chairman Paul Volcker. The other would have compelled banks to raise tens of billions of dollars because they'd have to spin off their derivatives-dealing operations into separately-capitalized affiliates within the bank holding company, pushed by Senate Agriculture Committee Chairman Blanche Lincoln. As currently practiced both activities are highly lucrative, annually generating billions for the nation's megabanks.
The proposals were launched after perceived political vulnerabilities -- the Obama administration announced the "Volcker Rules" after Massachusetts Republican Scott Brown won Ted Kennedy's old Senate seat, while Lincoln announced her proposal under threat by a liberal challenger in Arkansas for her Senate seat. Both came to become litmus tests used to gauge whether policymakers were for Main Street or for Wall Street.
Ultimately, despite widespread approval among those pushing for fundamental reform in the wake of the worst financial crisis since the Great Depression, yet perhaps aided by near-unanimous revulsion among those on Wall Street, both were watered down in front of C-SPAN cameras beginning around 11 p.m. ET. Democratic lawmakers had been rushing to complete the bill by Friday morning under a self-imposed deadline. The final vote was recorded at 5:40 a.m. The conference began their final day just before 10 a.m. on Thursday.
The so-called Volcker Rules originally banned banks from using their own taxpayer-backed cash to speculate in the financial markets. The federal government stands behind bank deposits, and banks have access to cheap funds from the Federal Reserve. Volcker argued that banks shouldn't use that subsidy to speculate.
After days of leaks to the news media that the Senate was looking to ease the restrictions, on Thursday afternoon Senate conferees confirmed the rumors: banks could invest up to three percent of their tangible common equity in hedge funds and private equity firms. Tangible common equity -- considered to be the strongest form of bank capital -- is comprised of shareholder equity.
A few hours later, the Senate amended its proposal, changing the metric from tangible common equity to Tier 1 capital. Banks have more Tier 1 capital than they have tangible common equity, so changing the requirement to the weaker form of capital allows banks to invest more of their cash in hedge funds and private equity funds. The concession was confirmed by Steven Adamske, spokesman for House Financial Services Committee Chairman Barney Frank.
Using JPMorgan Chase, the nation's second-largest bank by assets with more than $2.1 trillion, as an example, the bank would be able to invest an additional 40 percent of its cash, or an extra $1.1 billion for a total of $4 billion, in the activities that Volcker wanted to prohibit banks from engaging in, according to the firm's latest annual filing with the Securities and Exchange Commission.
For Bank of America, the nation's largest bank with more than $2.3 trillion, that change allows the firm to invest more than $4.8 billion in hedge and private equity funds, an increase of 80 percent, according to the bank's 2009 annual filing with the SEC. Morgan Stanley can invest $1.4 billion, a 58 percent increase, while Goldman Sachs can invest $1.9 billion, an increase of just 10 percent, securities filings show.
Rep. Paul Kanjorski became visibly angry. The longtime Pennsylvania Congressman tried to reverse, at least partly, the Senate's watering down of its own provision, calling it a "significant change."
"Some of our friends that are in the Senate ... are annoyed with that enlargement, as I am," Kanjorski said.
Noting of the Senate's new proposal that the House conferees "only had their offer for 20 minutes," Kanjorski added that his counter-proposal was a midway point between tangible common equity and Tier 1 capital.
Also, he noted, his compromise was "for purposes of getting along, but not to be taken advantage of, quite frankly."
His measure failed.
The most immediate beneficiaries are State Street Corp., the nation's 19th-largest bank with $153 billion in assets, and BNY Mellon, the nation's 13th-largest bank with $221 billion in assets, who pushed Brown, the Massachusetts Senator, to secure the relaxation of the Volcker Rules. However, all big banks will benefit.
That loophole survived.
Senate negotiators also announced they were carving out a class of financial institutions from the restrictions, namely systemically-important nonbanks.
As for the measure's proposed ban on banks trading with their own money, also known as proprietary trading, the agreed-upon provision calls for federal financial regulators to study the measure, then issue rules implementing it considering the results of that study. It could be anything from an outright ban to a barely-there limit.
Lincoln's provision, under fierce assault by the Treasury Department, the Obama administration, and a group of Wall Street-friendly Democrats called the New Democrat Coalition, also was softened.
Lincoln's proposal would have compelled the nation's megabanks to move their swaps-dealing units, which deal and trade in a type of financial derivative product, into a separately-capitalized institution within the larger bank holding company. The affected firms collectively would have to raise tens of billions of dollars to protect their swaps desks in case their bets went bad. Or, they could have disband the activity altogether.
Along with a few foreign banks, the nation's largest domestic banks essentially control the swaps market in the U.S. By forcing them to divest their units into separate affiliates, which in turn would compel them to raise money to capitalize these affiliates, Lincoln's measure could have forced them to scale down their operations. At the least, supporters say, it would have compelled them to have enough cash on hand in case their bets begin to sour, saving taxpayers from having to step in to prop up the banks like they did in 2008 -- taxpayer support that continues today.
Though Lincoln's measure had the support of three regional Federal Reserve Bank presidents -- James Bullard of St. Louis, Richard Fisher of Dallas, and Thomas Hoenig of Kansas City -- representing the Fed and bankers in the broad middle of the country from Kentucky to Colorado, they ultimately were outmatched. The Fed's Board of Governors, led by the nation's central banker, Ben Bernanke; Federal Deposit Insurance Corporation Chairman Sheila Bair; Treasury Secretary Timothy Geithner; and the nation's largest banks were united in their opposition.
Two minutes before midnight, Collin Peterson, a Minnesota Democrat, announced that a deal over Lincoln's divisive measure had been reached.
"There's been some work done by the administration and some of the senators on a potential compromise, I guess you could call it," said Peterson, chairman of the House Agriculture Committee, in a reference to the Obama administration.
The negotiations were not public.
Rather than banks being forced to spin off their swaps desks, they'd be allowed to keep those units dealing with "the biggest part of all these derivatives," Peterson said. The rest would be pushed out to an affiliate.
Under the agreement, reached late Thursday, banks would continue to be allowed to deal interest rate and foreign exchange swaps, "credit derivatives referencing investment-grade entities that are cleared," derivatives referencing gold and silver, and the firms would be allowed to hedge "for the banks' own risk."
Banks would be forced to push out to their affiliates derivatives referencing "cleared and uncleared commodities, energies and metals (with the exception of gold and silver), agriculture, credit derivatives referencing non-investment grade entities and all equities, and any uncleared credit default swaps," Peterson said.
"Frankly, the biggest part of all these derivatives, by far, are the ones that I named that are going to be able to stay in the bank," Peterson added. "Interest rate and foreign exchange are by far the greatest part of the amount of business that's involved here."
Lincoln, while praising the overall bill, acknowledged that there was only so much she could do.
"Our financial system is complicated and integrated and our time so limited that we couldn't afford to dig in our heels, but must do something," she said.
This report was updated to reflect the impact the change in the "Volcker Rules" would have on Bank of America, Goldman Sachs and Morgan Stanley. It also was updated to clarify that State Street and BNY Mellon were not the only beneficiaries of Sen. Brown's actions -- all big banks will benefit. The story also was updated to clarify that federal regulators shall consider their study in implementing the "Volcker Rules," rather than basing that implementation on their study.