Will Congress Kill Lewis' 3 'Remaining Threats' to Wall Street?

How threatened are banks by financial reform? Not very, according to Michael Lewis.

In case you missed it, he wrote an amusing op-ed for the New York Times this weekend written as a letter from the banking lobby to Wall Street. In it, he says that the financial industry has dodged most of the reforms that would drastically change its business. That's true. He then lists three remaining threats. They include, putting derivatives on exchanges, rating agency reform, and additional public debate. Are these really threats that stand a chance of sticking?


Of exchanges, Lewis writes:

The Senate appears intent on forcing our most lucrative derivatives business onto open exchanges, where investors can, for the first time, observe the prices we give them.

At this point, it would looks highly unlikely that banks can escape putting some portion of derivatives on exchanges. Both chambers' bills call for this change, though the Senate is more aggressive. But many derivatives just won't fit neatly onto exchanges, due to their customized nature. So the mere logistics here will make major change unlikely -- whether Congress likes it or not. As a result, exchanges probably don't pose much of a threat.

As explained here, the provision to force banks to spin-off their derivatives business, which Lewis briefly alludes to, will probably fall. But as argued here, that's probably for the best. Consequently, although this proposal would certainly be a threat, it's not likely that it will make it into the final bill.

Rating Agencies

Next, Lewis mentions Sen. Al Franken's (D-MN) aggressive provision that seeks to eliminate the conflict-of-interest that rating agencies can fall prey to by getting paid by the issuers to whom they provide ratings. This could make a big difference in the industry, but it's hard to see how this would hurt Wall Street. Loan issuers might not be able to get away with shoddy underwriting, but traders would ultimately be better off with more accurate ratings. If they have third-party analysts doing higher quality due diligence for them, then that lowers their internal costs.

And frankly, for mortgage securitization to make a comeback, investors need to become more comfortable with loan underwriting practices. So more conservative rating agencies could help Wall Street get this business going again, which would provide more funding for issuers. So although this might be viewed as a threat, it would ultimately work to the industry's advantage. Even though it's in everyone's best interest, it may be shed from the final bill, however, as it isn't contained in the House version.

The Populist Factor

Finally, Lewis says banks are worried about the angry masses. They fear that, as the financial reform battle becomes more exposed, rather than waged behind closed doors, the results will be less favorable to the industry. This is likely something that the industry does view as a threat, but it probably doesn't need to worry about. First, voters care a lot more about 10% unemployment than they do financial reform. So while some politicians might perceive additional regulation as a huge voter issue, they're probably overestimating it.

Second, even though some groups are making a lot of noise about the need to crack down on Wall Street, the financial reform battle hasn't captured nearly the populist interest that something like the health care reform battle did. Due to its complexity and the distance the average American feels to Wall Street, they just aren't gripped by the topic.

Finally, additional bad publicity probably isn't cutting into their consumer business. How many people have actually left the big 'evil' banks for smaller ones? Very few, because -- despite their poor customer service and the accusations of bad behavior -- you just can't beat the convenience. Is it annoying and undesirable to have some populist fury? Yes, but it probably isn't ultimately much of a threat.