Congress has agreed to use federal deposit insurance, which was designed to protect the savings accounts of consumers, to cover risky trading by the nation’s biggest banks.

In a small provision in the budget bill, Congress agreed to allow banks to house their trading of swaps and derivatives alongside customer deposits, which are insured by the federal government against losses.

The budget move repeals a portion of the Dodd-Frank financial reform act and, some say, lays the groundwork for future bailouts of banks who make irresponsibly risky trades.

“It’s both a stealth move and indefensible,” said Dennis Kelleher, the head of Better Markets, a group that argues for great oversight of banks. In a note to clients, he later called it “a sneaky, midnight repeal”.

The White House said on Wednesday it “strongly opposes” the provision.



“The main purpose...is to reauthorize the Terrorism Risk Insurance Program; this bill should not be used as a vehicle to add entirely unrelated financial regulatory provisions,” the White House said.

“If Wall Street gets the upside in big bonuses from its high-risk derivatives deals, then it should also have to pay the downside for any losses,” Kelleher wrote.

Richard Trumka, the head of labor union AFL-CIO, said his organizations also objected to the budget provision.

“Dodd-Frank forced too-big-to-fail banks to move potentially toxic speculation in derivatives out of their government-insured banks,” Trumka said in a statement. “Wall Street’s friends in Congress are trying to once again put the public on the hook for the most dangerous aspects of the financial system.”

Banks make their money primarily through two activities: lending out deposits to people or companies, and speculating on the markets. Laws like the defunct Glass-Steagall act were designed to separate the two activities. The Dodd-Frank rule recaptured a small part of that separation.

The budget provision, however, retracts the rule, which has been a thorn in the paw of giant banks like JP Morgan and Citigroup.

That rule, passed in 2010 and called the “swaps pushout rule”, dictated that banks had to keep certain arcane, risk-taking businesses away from customer deposits: swaps in stocks, commodities, and similar businesses.

Other derivatives, however, could still sit in the section of the banks protected by government backing. The derivatives business is a lucrative and concentrated one: 95% of the trading in derivatives in the US are done by the five biggest banks, Bank of America, Citigroup, Goldman Sachs, Morgan Stanley and JP Morgan. The banks have made more money in derivatives because they have government backing for deposits, Kelleher said. That’s no longer in place.

“The swaps pushout provision was saying US taxpayers should not be paying for risky trading activities,” said Kelleher.

Customer deposits – including the savings accounts of most Americans – are heavily regulated in size and scope by the federal government. The Federal Deposit Insurance Corporation (FDIC) provides a guarantee that, even if a bank goes under, customers can’t lose all of their money.

The FDIC was created in response to worries about “runs on the bank” in the 1920s and 1930s as stock market speculation, then the Great Depression, caused financial panic and destabilized the financial system.

Lobbyists for banks including Citigroup had previously tried to rewrite the provision, drafting as many as 70 of the 85 lines in one 2012 update.

The budget provision is a success for lobbyists and the banks they work for, but a loss to Americans who will have to foot the bill again if banks take too much risk, said Kelleher. Derivatives, particularly in mortgages, were at the center of the 2008 financial crisis as insurers like AIG nearly collapsed under the weight of their risk.

Excess exposure to derivatives created a restructuring of the financial system as investment banks like Bear Stearns and Lehman Brothers went out of business due to fear over their financial exposure. Others fared better, but went through intense fear in the fall of 2008: Merrill Lynch had to be sold to Bank of America to survive, and Goldman Sachs and Morgan Stanley had to forge new identities as commercial banks, which allowed the Fed to protect them.

The new budget provision once again acts as a promise that taxpayers will foot the bill for risky trading and speculation, Kelleher said.

“If things go wrong, [the banks] get to run to the Fed for bailouts. That’s incredibly valuable to them,” he said.

The surprise in the budget move is that everyone but banks considered the matter already settled.



The Dodd-Frank rule dictated that banks would have to find new homes for their risk-taking unit to prevent them from taking risks with customer deposits. Even so, mistakes occurred.

A notable example of a bank making a spectacular failing bet with customer money came in 2012, when JP Morgan used its $350bn chief investment office to make the infamous ‘London Whale’ trade, which led the bank to lose at least $6bn and led to a round of congressional hearings. JP Morgan increased its risk so much on the initial trade that the trader who initiated the bet called it “idiotic”.

Swaps and derivatives are financial instruments that allow speculators to make bets on the future prices of stocks, bonds and commodities. Banks and companies also use these swaps and derivatives to hedge against price rises in corn, oil, and other commodities they use regularly; airlines, for instance, regularly use derivatives to hedge the price of fuel, and McDonald’s, among others, has hedges on the price of corn.



Since the passage of the Dodd-Frank financial reform bill in 2009, banks and their lobbyists have not given up hope in pushing back regulation.

“Since the beginning of the financial crisis, the political world has buffeted the financial services sector with waves of new regulation in an attempt to punish the wicked and to make sure a similar crisis ‘never happens again’,” wrote Brian Gardner, Washington analyst for Keefe Bruyette & Woods.



Gardner said such efforts have been met with resistance from the financial services industry: “Ever since the law was passed in 2010, industry and observers (us included) have been waiting for a ‘technical corrections’ bill to fix mistakes in the law,”



Gardner, however, estimated the chances of that happening at under 60% due to “populism” that still exists in Congress, putting the largest banks “in the political doghouse”, he wrote.

“We think Senate Republicans will be wary about being seen as too close to Wall Street, and will avoid making changes to Dodd-Frank that may expose them to attacks.”

But Gardner echoed the hopes of many in the financial industry that yet more of Dodd-Frank’s reforms could be pulled back:



“With the major pieces of the Dodd-Frank Act mostly in place and with a change in control of the Senate, we think 2015 offers the sector the first legitimate prospect for policymakers to review some of the new regulatory landscape and see what works and what they got wrong.”

