Wall Street's biggest banks are engaged in the legislative equivalent of house-to-house fighting as the final provisions of the US financial reform bill are decided in Congress.
With lawmakers working to tie up the most sweeping reform of banking since the Great Depression by the end of this month, billions of dollars are at stake in almost every line of the legislation, and lobbyists for the industry are still confident of securing the defeat of some of the harshest provisions under discussion.
In particular, they are focusing on getting Congress to drop a provision that would force banks to sell off their lucrative derivatives trading businesses – but the industry is resigned to accepting a quid pro quo, namely new curbs on their ability to conduct proprietary trading.
Analysts at Citigroup yesterday estimated that up to 11 per cent of Wall Street's profits are at risk from the reforms, which are designed to make the financial system safer and avoid a repeat of the credit crisis. Worst hit would be Goldman Sachs, which could lose 23 per cent of its earnings.
The US Senate passed its version of a financial reform bill on 21 May, five months after the lower House of Representatives passed its own bill, and the pair now have to be married together before legislation is presented for the presidential signature – by a tentative deadline of 4 July.
Between now and then, senior politicians from both Houses and from both parties are going line by line through the legislation. This conference process began last Thursday and Wall Street has already succeeded in winning some minor victories, but the biggest fight – over exactly which bits of their business banks will be forced to exit – will come towards the end of the discussion.
The two key names to watch out for are Paul Volcker, the former chairman of the Federal Reserve and now a White House adviser, and Arkansas senator Blanche Lincoln, chairman of the Senate agriculture committee, which oversees the derivatives markets.
The "Volcker rule" would require banks to stop "proprietary trading" – that is, trading for their own profit instead of simply making trades for clients. It is simply unfair, Mr Volcker says, that banks operating with access to Federal Reserve assistance should be using that advantage for themselves rather than for clients.
The Volcker rule certainly means in-house hedge funds and private equity funds will have to be spun off; the question is how to distinguish proprietary and client trading. What is the difference between a bank buying an investment because traders think it will go up in value and buying it because they think there will be demand from clients?
Senator Lincoln's proposal added a whole new threat to Wall Street profits, since it demands that all trading in credit default swaps be conducted outside of banks. It was these opaque derivative contracts that led the financial panic to spread through the banking system in 2008, because banks had entered into trillions of contracts with each other but no one could trace who was exposed to what liabilities. The Obama administration preferred to force swaps trading on to public exchanges, ending the opacity, and does not support the Lincoln proposal, but it passed the Senate nonetheless.
The question now is whether it will survive the conference process, and Wall Street lobbyists are fighting to ensure it does not. Allies in the White House already appear to have had some success in watering down the plan. In a "clarification", Senator Lincoln suggested that her rules would allow banks to house swaps trading in a separate subsidiary which could only raise capital from shareholders or the financial markets. Analysts, however, believe the proposal could still be defeated in conference.
These debates are still to come. In the early stages of the conference process, lawmakers focused on easier areas. On Tuesday, for example, they voted to raise the cap on deposit insurance to $250,000 (£169,000) from $100,000, a move they hope will allow banks to attract more cheap money from savers. Yesterday, they were debating allowing shareholders to sue a company's banks and accountants when company officers commit securities fraud.
Credit rating agencies also scored an early victory, securing the removal of a provision that would have created a government panel to assign business to 10 federally approved agencies as a way of ending the conflicts of interest that many blame for the credit crisis. The big agencies are paid to give ratings by the issuers of debt or the creators of mortgage derivatives, something that lawmakers believe led them to mischaracterise many toxic mortgage derivatives as safe investments. Instead of the government panel, there will be a longer study of the issue, looking for a better solution.
Once the laws are in place, the focus will switch down to the regulators that will be charged with interpreting the laws and coming up with the detailed rules that govern things such as capital requirements and the characterisation of individual trades. Much of this will dovetail with the international rules coming out of the Bank for International Settlements.
Whatever big changes are decided, banks will be given years to implement them. The impact on earnings will therefore be delayed, while the impact on stock prices could be immediate – and perhaps surprisingly positive. "We believe a final regulatory reform law could be a positive catalyst as it should remove some of the overhang on the stocks that we have seen throughout the unpredictable regulatory reform process," Citigroup's bank analyst, Keith Horowitz, said. "It appears investors have already factored in most of the impact. Uncertainty has created very attractive buying opportunities."