How Wall Street Defanged Dodd-Frank
Nazareth and the ‘De Maximis’ Exception
Think of Annette Nazareth as the Democratic version of Scalia, doing what she can to slow down Dodd-Frank’s implementation by other means. Where Scalia barks at his adversaries, Nazareth shares “lingering concerns.” She cajoles rather than criticizes. Her résumé includes stints with Lehman Brothers and Citigroup and almost a decade with the SEC before moving to Davis, Polk & Wardwell, which counts every major bank as a client. She would be late for our appointment because of a last-minute gathering in Gensler’s office. There, she and others were hoping to convince him to delay the implementation of a set of rules taking effect that week that would require the biggest banks and others to start registering as swap dealers. But Gensler wouldn’t budge.
“You can’t win them all,” she says with a tight smile.
Nazareth’s offices look more or less like Scalia’s, which is to say they stand in stark contrast to the Office Depot clearance-sale look of their adversaries. Nazareth works on the top floor of a twelve-story tower four blocks from the White House. White orchids decorate the blond-wood conference room where we meet, and there is a carafe of fresh-brewed coffee to enjoy as we sink into the rich leather chairs. What about those who say she’s working to hollow out Dodd-Frank? I ask. “That’s such a simplistic view,” she answers. Sure, the CFTC, SEC and other agencies are struggling to implement the law. But that’s because of the immense complexity of the task, not the power of lobbyists and lawyers like herself. As she sees it, she’s a kind of pro bono adviser to public servants. “A huge amount of our time is spent helping regulators understand how to achieve their goal in a more effective way,” she says.
Of course that’s how she’ll frame it, counters Dennis Kelleher of Better Markets. “Wall Street can’t say, ‘We’re against Volcker because it’s going to kill our profits and mean smaller bonuses.’ So instead it’s ‘Volcker is going to kill the corporate bond market,’ or ‘Volcker is going to wreck the economy.’” The true genius of Annette Nazareth and advocates like her, he adds, is their ability to make it sound like they’re helping—all the while turning a simple new rule into one that stretches for 200 pages, creating more carve-outs and exceptions.
And then there’s the fight over what insiders call the “de minimis exception,” which found Kelleher crossing swords with Nazareth and some of her biggest clients. The question confronting the CFTC—as well as the SEC, which is responsible for a small sliver of the derivatives market—was this: Who would need to register as a dealer in order to sell derivatives in the new open markets that Dodd-Frank was enabling? The original proposal on the table was for a “de minimis” exception of $100 million: only if your annual derivatives revenue topped $100 million would you have to go through the expense and bother of registering and then complying with a strict regulation regimen. But then came all those reasonable arguments from the likes of Nazareth, and the exemption was inflated to the point of absurdity: a threshold of $8 billion, which would shrink to $3 billion after three years, prompting Kelleher to call it the “de maximis” exception.
“Only in Washington, DC,” Kelleher says, “can you get a ‘de minimis’ exemption of $8 billion.”
‘The Beast Hasn’t Been Killed Yet’
Although the CFTC is further along in its work than the other agencies, that only underscores how much work remains to be done on Dodd-Frank nearly three years after its passage. The CFTC has finalized forty of its sixty rules, according to the Dodd-Frank Progress Report, which Nazareth’s firm publishes each month. That leaves a lot of rules that still need to be finalized before there’s a workable derivatives market. Still, compared with the other agencies, the CFTC has proved to be a speed demon. The SEC has barely finalized one-third of its rules, and the various bank regulators (the Fed, the FDIC and the Office of the Comptroller of the Currency) are faring even worse. As a group, they’ve failed to publish draft language for one-third of their portfolio of assignments and have finalized only 27 percent of its rules. So while a new Volcker Rule might not have prevented an embarrassment like JPMorgan’s “London Whale,” the bank probably wouldn’t have lost $6 billion on the deal, and the regulators could have potentially seen what was happening sooner.
Since January, banks and others have been filing the requisite paperwork to establish themselves as registered swaps dealers. But there won’t be a market in which to do business until the CFTC’s five-person commission finalizes the relevant rules. There are also big policy issues to be worked out, not the least of which relates to how the CFTC treats the foreign subsidiaries of US-based banks. Can Citigroup simply run some of its derivatives book out of the Cayman Islands, as it was doing in 2008, thereby avoiding Dodd-Frank by shifting its derivatives business offshore? The answer right now is yes, it can—and that’s what the answer will be until the CFTC definitively says otherwise.
But the champions of financial reform are worried less about the CFTC and more about Congress and the courts. Gensler can argue that the CFTC must poke its nose into the foreign subsidiaries of US-based banks because American taxpayers will be on the hook if one of those banks blows itself up. But even if Gensler’s side wins, that logic may not hold up in court. More immediately, there are five derivatives-related bills currently working their way through the House Financial Services Committee that would introduce “huge loopholes” into Dodd-Frank, says John Parsons, a senior lecturer at MIT’s Sloan School of Management and co-author of the popular Betting the Business blog. Maybe they’re just “fundraising bills,” to use Mierzwinski’s phrase. But Parsons is worried that they might be more, given “all those lobbyists swarming Capitol Hill trying to pick off individual Democrats now that the heat from the crisis is over.”
Meanwhile, the stock market is hitting new heights and the banks are roaring back, selling the very same “risky amalgams of mortgages and loans” they sold during the boom, The New York Times reported on its front page in April, and minting more “arcane-sounding financial products” like the kind that doomed the economy only five years ago. And so, despite Dodd-Frank, we are still threatened by the same dangers. “It’s like a horror movie, and the beast hasn’t been killed yet,” Parsons says. “You can’t be too triumphant just because the first blows had the beast weakened.”
Our blogger Greg Kaufmann writes that bank accountability activists continue to send a clear message to the big banks: “You can run, but you can’t hide.” And one of our Nation Builders has posted an excerpt from Neil Barofsky’s Bailout: An Inside Account of How Washington Abandoned Main Street While Rescuing Wall Street addressing the serious limitations of Dodd-Frank bill.