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The Origins of Blanche Lincoln's Disastrous "Section 106" Proposal

By Anonymous

Bloomberg has an excellent story on the origins of Blanche Lincoln's disastrous swaps proposal (the infamous "Section 106") ? Bloomberg: How ?Hard to Fathom? Derivatives Rule Emerged in U.S. Senate. Short version:

The idea arose from a mix of policy debate, campaign politics and personal relationships -- and little consideration of the business or economic implications, according to interviews with Senate aides, administration officials and industry lobbyists.

Read the whole article. Oh by the way, Paul Volcker has now also come out against Section 106. Sheila Bair penned a letter to Lincoln sharply criticizing Section 106 last week, and the Fed circulated a memo on the Hill a couple weeks ago arguing that Section 106 should be deleted.

Of course, it looks like the usual suspects on the left will still loudly support it, because right now, pretending to fight Very Important battles with Wall Street on financial reform is really all they care about. Unfortunately, "experts" like Michael Greenberger and Robert Reich have already come up with absurd/dishonest arguments for why this is actually "real reform" that the left should fight for, and why anything less would be a give-away to Wall Street. They should be embarrassed.

Greenberger, for instance, is apparently willing to claim, with a straight face, that major nonbank swap dealers "would not [be] shadow banks." I kid you not. That's how far defenders of Section 106 have to twist their logic. And Reich arguably one-upped Greenberg yesterday with this doozy:

Senator Blanche Lincoln, Democrat of Arkansas, has pushed an amendment that would force big banks to spin off most of their derivative businesses ? bringing derivatives into the open and insulating them from the kind of proprietary trading that can cause so much havoc. But the Administration thinks Lincoln is going too far and has instructed its allies in the Senate not to go along. Lincoln should stick to her guns.

Wow. That's just incoherent. Reich apparently thinks that pushing the vast majority of swaps away from banking regulators would be "bringing derivatives into the open." That claim literally makes no sense. Also, it's 100% untrue that Section 106 would "insulate" banks from proprietary trading. The whole point is that Section 106 doesn't distinguish between prop trading and market-making. It bans banks from doing both. Reich clearly has no clue what Lincoln's Section 106 proposal is even about ? and yet he's already declared that failing to support it would be "pandering to Wall Street."

Look, this isn't difficult. Swaps are a critical part of modern banking. Just like normal commercial lending requires banks to serve as intermediaries between savers and borrowers, the swaps market also requires intermediaries (known as dealers, or market-makers). These intermediaries borrow short and lend (through swaps) long; they are susceptible to runs; and their disorderly failure can cause severe collateral damage to the real economy. Pretending that swap dealers aren't engaged in an important banking function by refusing to call them "banks" is not just delusional, it's also dangerous. And yet this is what Blanche Lincoln's Section 106 proposal aims to do.

Period.

Full post as published by Economics of Contempt on May 08, 2010 (boomark / email).