Wall Street in the Dark on New Banking Regs

A new proposal put forth by Sen. Blanche Lincoln could force banks to spin off their highly profitable derivatives trading to subsidiaries. But few on Wall Street or on Capitol Hill seem to understand exactly how the new rules would work.

A new proposed regulation in Congress could force banks to shuffle their swaps desks off to separate subsidiaries.  The highly profitable desks handle the bulk of most banks derivatives trading.

After a quick, informal survey of some finance professionals and Hill staff though, I could not find anyone who could tell me exactly what Sen. Blanche Lincoln’s Section 716 proposal to require banks to "spin off" swaps desks would actually do or how it would impact the banking business.

One unusually frank article from TheStreet.com basically argues that banks and regulators aren't entirely sure either. The proposal, which has open support from at least two regional Fed heads (although opposition from the Federal Deposit Insurance Corporation), has a pretty good intention: the risky, complex swaps business simply shouldn't get federal backstops or even get near them.

That said, there are no explicit guarantees right now for swaps operations connected with banks and, in theory, current rules already keep them mostly separate from banks federally insured operations. Lincoln's proposal, best as I understand it, would require a strong "wall" between swaps and banking and would probably impose higher costs on swaps businesses but would probably let swaps desks continue to exist within the same financial "group" (although not the same company) as banks.

Right now, the most important principle that conferees working on the finance bill should consider is: "first do no harm." Maybe some swaps experts can offer really good ideas of what the bill would do but, if so, they ought to speak out now. Because, best as I can tell, Hill staff and the financial press are basically clueless about what the proposal will actually do. Before they write Sen. Lincoln's proposal into law, members of Congress should, at minimum, have a better idea of what it's going to do.