US lawmakers approve financial overhaul

Banks will be forced to spin off their swaps desks, but US lawmakers also made concessions to Wall Street  as they finalised sweeping financial reform in the early hours of Friday morning.

Members of Congress also voted to impose a tough proprietary trading ban on deposit-taking banks, new conflict of interest rules and a surprise $19bn levy on the industry in a conference session that lasted longer than this week’s record tennis match at Wimbledon and contained more turgid back-and-forth.

Tim Geithner, US Treasury secretary, welcomed the move by Congress saying it provided “crucial momentum” for global efforts on financial reform.

“As President [Barack Obama] travels to Toronto to attend the G-20 summit, Congress has shown that America is ready to lead by example,” said Mr Geithner.

Praising lawmakers, President Barack Obama said on Friday, “We are poised to pass the toughest financial reforms since the ones we created in the aftermath of the Great Depression.”

Towards the end of the 20-hour debate, Barney Frank, chairman of the House financial services committee, announced the surprise bank fee, saying it was legitimate to ask financial institutions whose “collective errors” had damaged the economy to pay the – unexpectedly high – cost of the reform.

“We think that to go to the Goldman Sachses, JPMorgan Chases, Blackstones … is reasonable,” he said.

But there was some celebration on Wall Street after language was published that would allow banks to invest up to 3 per cent of their tier one capital in hedge funds.

However, a ban on banks investing in hedge funds was relaxed to allow them to invest up to 3 per cent of their tier one capital. An earlier proposal allowed 2 per cent of tangible common equity – a difference worth billions to the biggest banks.

Blanche Lincoln, the Senate agriculture committee chairman, won a hard-fought battle to force banks to spin off their swaps desk into separately capitalised affiliates. She moderated the provision, which had been opposed by the Federal Reserve and pro-Wall Street Democrats in Congress, but kept the core intact in what should prove a complicated and potentially expensive restructuring.

Before any of the new rules become law they face final votes next week, but congressional leaders and the Treasury have strained to secure support in the last few days and believe they will overcome the hurdle, delivering Mr Obama’s second big legislative accomplishment after healthcare reform.

The heart of the bill has already been agreed in recent days, with new government powers to wind down a failing financial institution that threatens the financial system, new regulatory tools to combat systemic risk and a Consumer Financial Protection Bureau to regulate credit products.

Although the text pledges to recoup any costs associated with a wind-down from the financial industry, it emerged on Thursday night that the independent Congressional Budget Office had decided there were potential liabilities to the taxpayer and other administrative costs and put the total at $14bn.

That provided an unexpected revenue hole that the legislative drafters have to fill. Mr Frank said banks with more than $50bn in assets and hedge funds with more than $10bn would be taxed on a risk-adjusted basis – with hedge funds paying proportionally more than mutual funds – to raise the cash up to a limit of $19bn to cover room for error.

It is entirely separate to the proposed $90bn bank tax, proposed by Mr Obama, which has been languishing in the Senate.

After hours of wrangling in private, a Senate team finally published its new version of the “Volcker rule”, including a strict ban on banks trading for their own account and a conflict of interest bar on sponsors of asset-backed securities designed to hit Goldman Sachs.

Tim Geithner, Treasury secretary, helped break the impasse between a faction of lawmakers pushing for punishing restrictions on banks and another urging moderation, according to people familiar with the negotiations.

Carl Levin, the Democratic senator from Michigan, argued for a pure rule with minimum exemptions while Scott Brown, the Republican senator from Massachusetts, demanded broad exemptions. Mr Geithner and the bill’s two congressional leaders – Mr Frank and Chris Dodd, the Senate banking committee chairman – had preferred to maintain a lower limit on fund investment but reluctantly gave in as they scrambled for votes.

Votes due next week, including a tricky vote in the Senate that requires 60 senators to support it, should bring the reform effort to a close, though there remains tension between lawmakers over the Volcker Rule and the Lincolns swaps rule.

Bankers said the 3 per cent investment limit was a positive sign for the industry as it would allow financial institutions to keep ownership of their internal hedge funds and private equity funds, albeit with less proprietary investment.

“It is a victory for us because it gets away from this concept that we would have to spin off or sell most of these businesses,” said a senior Wall Street executive.

In practice, however, the rule could force banks to reduce the amount of money they invest in their internal asset management vehicles.

The new rule would allow Citigroup, for example, to invest about $3.5bn of its own capital in its hedge funds and private equity funds, compared with the $5bn or so the company has invested.

The limit for JPMorgan Chase, which owns a hedge fund called Highbridge and a private equity group, would be about $2.8bn. People close to JPMorgan said the company had more than $1bn invested in Highbridge alone.

Limits for Morgan Stanley and Goldman Sachs, securities houses with smaller balance sheets, would be lower: about $900m for Morgan Stanley, which has already signalled its intention to sell its stakes in hedge funds, and about $1.78bn for Goldman, which has a large and very profitable fund business.

Bankers stressed that a lot of the in-house money poured into the funds was meant to be replaced by outside investments once the funds got off the ground, leading to a natural reduction in the levels of proprietary investments.

Among other issues considered, lawmakers moved towards an agreement that should boost the coffers of the Securities and Exchange Commission and the Commodity Futures Trading Commission but retain some congressional oversight of their funding.

“Madoff, Stanford, Bear Stearns and Lehman may make a compelling case that the SEC needs more resources, but they also ought to make the case that the SEC ought not to go unmonitored,” said Richard Shelby, the senior Republican on the Senate banking committee.