Financial reform bill gives consumers more protection and Merkley two-thirds of a loaf

The financial reform agreement reached as dawn broke Friday includes a provision written by Sen. Jeff Merkley prohibiting banks from using their own money to make speculative trades and making deals that bet against their own customers.

But the language that Merkley and Sen. Carl Levin spent months selling to a skeptical Senate and Treasury Department was weakened at the last moment.

“There’s a potential danger in that there’s a loophole,” Merkley said in an interview Friday.

“Still, the bill prohibits proprietary trading and has language that prevents abuses to investors.”

In addition to convincing the House and Senate negotiators to add the proprietary trading language, Merkley also scored two other items — a requirement that banks and financial institutions must set aside a great amount of money to cover potential losses and the so-called Goldman Sachs provisions that outlaws banks from selling an investment to a customer and then making a separate deal that bets on the customers’ investment to fail.

Essentially, the Merkley/Levin requirement would limit commercial banks from engaging in Wall Street trading if they’re also conducting trading activities on behalf of clients. Such separation between deposit-taking commercial banks and so-called proprietary trading had been in effect since the Great Depression under the Glass-Steagall Act of 1933. However, deregulation in recent decades weakened that traditional separation and the act was repealed in 1999.

Partially separating those activities has been a primary goal of some economists and consumer advocates who say the ability of banks and financial institutions to roam free and make all variety of trades helped cause the economic collapse.

Efforts to restore at least partial separation between commercial banks and Wall Street speculation has become known as the Volcker Rule. Former Federal Reserve Chairman Paul Volcker, an adviser to the Obama administration, championed the concept over the reservations of Treasury Secretary Timothy Geithner.

The move, however, was opposed by big banks and financial institutions as well as the Treasury Department. In the end, the Merkley/Levin approach was diluted to allow financial institutions to make smaller “de miniums” trades that allows them continued access to those markets — and potentially big profits — while also theoretically limiting risk.

Under the compromise forged by the conference committee, deposit-taking commercial banks could still invest in hedge funds and private equity funds, but their participation in these high-risk funds would be limited. Banks could own no more than 3 percent of such funds, and the investment couldn’t exceed 3 percent of the bank’s capital. The changes calmed the financial industry.

Vikram Pandit, CEO of the financial giant Citigroup, said he hopes the measure “will provide direction and stability for the financial system going forward.” Some analysts said investors were relieved to know the new rules didn’t end up being even harsher.

Merkley worries that the exemption is “too big of a loophole” but conceded that adding the change was the price of getting other items into the final compromise.

“The inclusion of a ban on proprietary trading is a victory,” Merkley and Levin said in a joint statement. “If implemented effectively, it will significantly reduce systemic risk to our financial system and protect American taxpayers and businesses from Wall Street’s risky bets.  This is an important step forward from the current system that has placed few limits on speculative trading by either banks or other financial firms.  Now banks will be prohibited from doing these trades and other financial giants will have to put aside the capital to back up their bets.