Wall Street’s separation anxiety is misplaced
Big U.S. banks are getting separation anxiety. They don’t want to spin off their lucrative derivatives desks, even into subsidiaries. The idea, which is part of the financial reform legislation being debated in the U.S. Senate, has merit. It would rid the derivatives market of perceived taxpayer support and discourage risky speculation. But international cooperation will be critical.
Some $30 billion of revenue is at stake, so the concern from Wall Street isn’t surprising. The proposal may not survive Senate horse-trading, and even if it does, it’s not clear whether it would require completely severing the derivatives apron strings, or only a loosening by way of separately capitalized derivatives subsidiaries.
Either way, banks have sounded the alarm. The separation would require heaps of new capital — more than $100 billion by one industry estimate. There also would be uncomfortable unwinding pains, including ones related to technological infrastructure and ending of the one-stop financial shop.
Yet Blanche Lincoln, the senator who shoehorned the provision into the bill, reckons there should be a clear division between banking activities the federal government should support or at least — through the Federal Reserve — provide liquidity to, and riskier business it should not. This makes some sense in many ways.
Standalone swap desks would inevitably render derivatives more expensive, and thereby discourage excessive speculation. The set-up also would give banks cover, whether they think they need it or not, from accusations that taxpayer subsidies are backstopping risky trading. If banks find excising swaps desks alone too difficult for clients who want a suite of trading services, they could always return to a full separation of traditional and investment banking functions.
A big problem with the proposal, as written, is that it looks as if it would send much derivatives business to non-U.S. banks. That’s if other jurisdictions didn’t follow suit. U.S. banks would be safer, but at the expense of their competitiveness. Without overseas cooperation, the problem of global systemic risk wouldn’t be getting addressed either. To work effectively, separating banks from their derivatives would benefit from U.S. lawmakers simultaneously bringing international counterparts together.