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The watering down of Wall Street reform

When Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010, its intention was to create a raft of stronger financial regulations, all with the lofty aim of avoiding another painful financial crisis.

But some of those reforms may soon be weakened, thanks to a Republican-backed bill in the House that would water down some Dodd-Frank provisions. The bill would revise the so-called Volcker rule, which prohibits banks with government backing from high-risk trading and owning collateralized loan obligations, activities that were among those blamed for the financial collapse.

Collateralized loan obligations, or CLOs, may ring a bell. Structured products -- such as collateralized debt obligations (CDOs) and CLOs -- were the types of complex financial instruments that imploded during the financial crisis. The market for CLOs, which use leveraged bank loans as assets, has rebounded tremendously since the financial crisis, with more than $124 billion of these securities issued last year. Some of the country's biggest banks, including JPMorgan Chase (JPM) and Wells Fargo (WFC), hold the most exposure.

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"Derivatives gambling by the biggest banks on Wall Street by in large caused the last crisis and caused the need for bailouts," Dennis Kelleher, chief executive officer of the nonprofit Better Markets, told CBS MoneyWatch. The Volcker rule "is relatively narrow because it only applies to the highest-risk activities and the most dangerous products. It's a law that's identifying those high-risk activities and putting protections between those and American taxpayers."

The new bill's name, the Promoting Job Creation and Reducing Small Business Burdens Act, fails to hint at what's tucked inside: a chipping away of the regulatory environment. The bill would allow banks to keep their CLOs until July 2019, two years later than the Volcker Rule currently requires. It also proposes loosening other regulatory reforms, such as the requirement that some private equity firms register as brokers with the SEC, and it allows looser regulations on derivatives.

Better Markets, which advocates for financial regulation, says banks don't need an additional two years, given that the Volcker Law already provides ample time for banks to come into compliance with the rule.

JPMorganChase declined to comment.

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Still, supporters argue that the bill would give banks only more time to divest their holdings and that a stronger regulatory environment will remain.

"The recent hyperbole on banking reform might score political points, but the reality is the core of Dodd-Frank is going nowhere," Tony Fratto, a partner at consulting firm Hamilton Place Strategies, said in a statement.

The Financial Services Roundtable, an advocacy group for the financial services industry, is supporting the delay to the Volcker Rule because it says the change will allow banks to sell their CLOs without resorting to a "fire sale," according to Francis Creighton, executive vice president of government affairs.

The industry "would be forced to sell all of these in two years" without the changes, he noted. "These are relatively large deals and the market is somewhat inactive." If banks need to divest within two years, that would lead to discounting of the CLOs as they would flood the market, he said.

Creighton added, "We're not trying to change the rules but smooth out the rules so we don't have a fire sale on the assets."

According to research published by Hamilton Place Strategies, the cumulative 20-year default rate of CLOs is 0.41 percent. The Volcker Rule would also hurt smaller bank holding companies given that many hold CLOs, the group said.

While it's true that some smaller banks do hold CLOs, four large banks account for 72 percent of U.S. bank-held CLOs, according to Better Markets. JPMorganChase alone owns more than one-third of all bank-held CLOs in the country.

So what will happen next? While the bill will likely pass the House, it's unclear what will happen in the Senate. The White House, however, has vowed to veto the legislation.

Given President Obama's stance, it may seem as if the efforts to weaken Dodd-Frank won't get very far, but Better Markets argues that the issue is much larger than this one bill: Republican Party leaders have made it a top priority to revamp Dodd-Frank and financial regulatory reform.

"It's part of the relentless war by Wall Street to repeal financial reform, which will dramatically increase the likelihood of another crash," Kelleher noted. "Everyone in America has a personal stake in making sure we never have another financial crisis."

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