Why Elizabeth Warren hates the government funding bill

Lurking in the omnibus appropriations bill that will prevent the government from running out of money and shutting down is a provision that has nothing to do with government spending. It has to do with financial regulation — and it’s gotten Elizabeth Warren pissed.

The omnibus would repeal Section 716 of the Dodd-Frank financial regulation bill that passed back in 2010.

Among financial regulation junkies, Section 716 is referred to as the “swaps pushout.” A swap is actually more or less what it sounds like. One party (normally a company, but also possibly a large non-profit or a government) to a swap agrees to give up the cash flow associated with one financial asset in exchange for getting the cash flow associated with another party’s financial asset.

Many swaps are more or less standardized and deal with things like currency values or the interest rates on major government bonds.

But there are also more custom swaps, such as the Credit Default Swaps that let players bet on the potential bankruptcy of a given country or company or the failure of a new financial product. Section 716 specifically targets those custom swaps, and says that FDIC-insured banks can’t be trading them. They have to be “pushed out” to other entities that don’t benefit from federal assistance.

Mike Konczal of the Roosevelt Institute has an accessible argument for Section 716. The basic case, however, is pretty simple. When FDIC-insured institutions fail, taxpayers are left holding the bag. So regulators need to closely monitor what happens with FDIC-insured money. But custom swaps are, by their nature, hard for regulators to supervise. Forcing them out of insured institutions reduces risk in the banking system.

Moreover, allowing banks to trade swaps with FDIC-insured money constitutes an unfair subsidy to the swaps industry.

On one level, the case is obvious. Banks don’t like it because it would be more profitable to trade swaps with FDIC-insured money and banks have a lot of clout on Capitol Hill. The repeal provision appears to have been written by Citigroup’s lobbyists. But there are a lot of elements of the Dodd-Frank bill that banks don’t like. Section 716 has attracted a disproportionate level of lobbyist attention because quite a few influential bank regulators — including members of the Obama administration — opposed an initial version of it.

That made it a bit of a weak link in the Dodd-Frank firmament. The result of that opposition was the promulgation of a compromise version in which the most standardized forms of swaps are exempted from the rule.

That’s brought around many of the initial opponents, but banks still don’t like it. Their argument on the merits is that it’s actually safer to keep the swaps inside the FDIC insured institution because that way their value can be preserved for the benefit of the bank’s creditors — including the FDIC.

Proponents of the current version of the rule argue that this has to be balanced against the risks posed by exotic financial products. They say keeping the standardized swaps in and the custom swaps out strikes the right balance. The industry disagrees.

In the grand scheme of things, Section 716 is not earth-shattering in its impact. Repeal would not end all regulation of derivatives, and it would not repeal the Volcker Rule which has some similar effects. But proponents of stricter regulation have two main concerns.

One is simply directional. They feel the banking sector remains under-regulated in the wake of Dodd-Frank, not over-regulated, and that any moves to loosen the chains are simply a step in the wrong direction.

The other concern relates to political economy. As long as lobbyists are fighting on Capitol Hill about swaps pushout, they have less time to fight about other things. If the banks win this fight, then that frees up time and resources to fight for the repeal of other provisions. And the precedent of repealing a bank regulation in a government funding bill would be very dangerous. If it works this time, the banks may ask for more repeals next time around.