From The State of the Union Address

About one-third of the way through the President's State of the Union Address on Wednesday night there came the following passage:

As hard as it may be, as uncomfortable and contentious as the debates may become, it's time to get serious about fixing the problems that are hampering our growth.

Now, one place to start is serious financial reform. Look, I am not interested in punishing banks. I'm interested in protecting our economy. A strong, healthy financial market makes it possible for businesses to access credit and create new jobs. It channels the savings of families into investments that raise incomes. But that can only happen if we guard against the same recklessness that nearly brought down our entire economy.

We need to make sure consumers and middle-class families have the information they need to make financial decisions. (Applause.) We can't allow financial institutions, including those that take your deposits, to take risks that threaten the whole economy.

Now, the House has already passed financial reform with many of these changes. (Applause.) And the lobbyists are trying to kill it. But we cannot let them win this fight. (Applause.) And if the bill that ends up on my desk does not meet the test of real reform, I will send it back until we get it right. We've got to get it right. (Applause.)

Frankly, I'm not sure what this means. "Look," I'm not interested in pedantry for its own sake, but Obama now has two very different financial reform plans in the air. There is on one hand the plan that the Treasury Dept under Geithner put together in June of last year, which centers on enhanced wind-down authority for the Fed, bank capital requirements, the creation of a new consumer protection agency and the regulation of over-the-counter derivatives. Some of the elements in this plan did pass the House of Representatives on December 11.

There is on the other hand, a very different set of proposals, centered on the so-called Volcker Rule, which would bring back something like the old Glass-Steagal segmentationb of thebanking industry. I say "something like" with deliberate vagueness. It is not a simple return to Glass-Steagal. My point, though, is that Obama didn't announce this new plan until January 21, 2010. So there was obviously nothing like it in the bill passed by the House in December.

So, does the above passage mean that he is already retreating from the Volcker Rule, and that he is angling instead to take what he can get from the June Plan? Which one is the "real reform" that he says he would demand of any bill that ends up on his desk?

Damned if I know.

OTC derivatives bill

On Friday, Rep. Barney Frank (D-MA), the chairman of the Financial Services Committee of the House of Representatives, released a "discussion draft" of legislation to regulate over-the-counter derivatives.

This draft takes a point of view distinct in an important respect from that of the administration. The White House/Treasury proposals have focused on standardizing OTC derivatives so that they could be processed through clearing houses, in the expectation that such clearing would lower the risk of such instruments to the broader financial system.

Look at this from the point of view not of hedge funds or speculators, but of companies who really use derivatives to hedge their operational positions. Airline companies, for example, are in the market for derivative products in regard to oil prices. Why? because sharp increases in oil prices proves very costly to their operations, so they look for a way to make such a sharp increase work for them through the derivative, getting them back in one pocket what that development takes away from them via the other.

Yet airlines might have a tougher time doing this under the Obama proposal than they'd like, because the centralized clearinghouses could require they put up cash or liquid assets as collateral. That would burn a hole in their balance sheets.

The discussion draft says that the requirement for OTC swaps to be cleared centrally would not apply if "one of the counterparties to the swap is not a swap dealer or other major swaps participant." Learn more here.

See the discussion draft itself here.