Does financial reform hit Wall St where it hurts?

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Two distinct narratives have emerged from last week’s approval by the U.S. Senate of financial reform legislation. One: Of an historic overhaul of the financial industry for reformers demanding accountability for Wall Street and new regulation to rein in the wild speculation and consumer abuses that led up to the 2008 economic meltdown. Two: Of Wall Street lobbyists breathing a sigh of relief that they managed to kill the biggest game-changers in reformers’ playbook.

Both images hit the mark. There are a lot of things for the financial industry to dislike in the plan that came out of the Senate, including new eyes and ears on two of the biggest drivers of the crisis: consumer lending abuses and speculation in the completely unregulated derivatives market. Still, Congress failed to enact any of the game-changing reforms, like breaking up the biggest banks, that could fundamentally re-define how Wall Street operates.

As Wall Street profits rebound to pre-crisis levels, Americans are in the same economic straits we were in right after the collapse. Millions of homeowners have been and continue to be foreclosed on. Billions in lost retirement savings for older Americans will never be regained. Just a fraction of the 8-11 million jobs lost (depending on who’s counting) have been replaced. Just as scientists can’t predict how long it will take for the Gulf Coast to recover from the environmental devastation of the BP oil well blowout, it may be a decade or more before Americans recover from the economic devastation of the financial collapse.

The silver lining to the meltdown was supposed to be that it finally created the political will to overhaul a financial system that long ago stopped working for the American people. The crash and burn of the Wall Street casino economy provided irrefutable proof that corporations can and will not police themselves, that bigger is not always better, and that protecting the public is often the same thing as protecting the economy.

The Senate has cued up another Obama victory with the biggest overhaul of financial regulation since FDR. When the financial bill leaves conference and is finally signed by the President, it will enact new rules for a financial system that had swung into Ayn Rand territory as far as oversight is concerned. But even as implementation of the current bill takes center stage, the administration and Congress can’t announce mission accomplished and go home. (Check Arianna Huffington’s thoughts on what mission was accomplished.) Many reforms central to ending ‘too big to fail,’ protecting consumers
and changing the rules on Wall Street were ignored in this bill but demand action if we expect to remake the American economy.  The public is still demanding that the financial system work for them. The question is what politicians do with that directive. 

What’s in the House and Senate bills, expected conference fights, and what’s needed moving forward:

Derivatives. Regulation of the 600 trillion-dollar shadow market in derivatives may be the biggest issue still up for debate going into conference. The Senate’s bill is much stronger than the House’s, requiring most derivates to be traded on exchanges and cleared, and containing a requirement that banks get rid of their derivative trading desks, or at least move them into subsidiaries walled off from the bank’s taxpayer-insured deposits. Wall Street has declared this provision Undesireable No. One and it will be a key test of Congressional will to hold onto meaningful reform. Both bills are also missing key fixes. The so-called “Volcker Rule,” in an amendment championed by Sens. Merkley and Levin, would have definitively prohibited banks from using taxpayer-insured deposits to make speculative investments for their own profit. It wasn’t allowed a vote. Also denied a vote: Sen. Cantwell’s effort to make sure it is actually illegal to break the new derivatives trading and accountability rules.  And an amendment from Sen Dorgan that would have banned  derivatives known as ‘naked’ credit default swaps, those purely speculative securities that have no positive economic purpose but inject huge risk into the system (think AIG), didn’t make it into the bill.

Consumer Protection.  Both Senate and House bills create a brand new consumer regulator who will take on the job of protecting consumers from the abusive lending practices that helped contribute to the economic collapse. Taking that job from the seven current regulators who are nominally responsible for protecting consumers, but in reality have their eye on  bank profitability not responsible lending, should mean a sea change in consumer financial protection. A lot depends on how serious that agency is on rulemaking and enforcement, and how much it involves the public in its actions. And the bankers’ lobby targeted preemption of state laws, to bar states from enacting and enforcing local rules to protect consumers from bank abuses, as its top priority. Both House and Senate bills watered down states’ ability to protect the public. And while the agency will have the authority to write new rules for nearly all lenders, it will be hamstrung by an inability to enforce those rules against all but the largest lenders. Other questions that remain to be resolved in conference: Will the consumer agency be fully independent, as in the House bill, or be housed in the Federal Reserve? (Even the Fed is reportedly uncomfortable with housing consumer protection. As explained to Politico by Barney Frank: “The Fed feels it’s like, you know, having your ex-wife’s brother living in the house after you got a divorce.”) Will car dealers (the biggest source of consumer complaints to better business bureaus across the country) or anyone else gain full immunity from the Agency?
“Too Big To Fail”. The bills are supposed to ensure that no bank is ever again so big that taxpayers have to bail out failing financial firms. They move in that direction, both creating a new resolution process to wind down failing banks so that bankruptcy or bailout are not the only options. But little would actually prevent banks from getting too big to fail, or too interconnected to fail, in the first place.  For instance: the House puts a 15:1 cap on bank leverage. Even that huge number was too big to get by the Senate. An amendment by Sens. Brown (OH) and Kaufman that would have enacted leverage caps, as well as a cap on the size of banks, failed. And what about rebuilding the walls between the banks holding Americans’ savings and home loans and investment banks whose speculation caused the last crash, and
arguably this one? A bipartisan bill to reinstate those Glass-Steagall Act walls, built by FDR in the 30s and rolled back in the deregulatory push of
the 90s, was introduced by Sens Cantwell and McCain and also failed to get a vote.

Not to mention a host of lower-profile but equally important questions: Will Treasury gain new power to deregulate insurance by overriding state insurance protections on behalf of foreign insurers? Will hedge funds and private equity firms escape new oversight entirely? Will investment advisors be required to work in their clients’ interests? Will credit rating agencies shed their inherent conflict of interest by being assigned randomly to rate securities (instead of being chosen based on their willingness to give a good rating regardless of actual value)? Each issue faces resolution between the differing House and Senate bills.

The bills approved by the House and Senate take the financial industry to task, but leave too much discretion in the hands of federal regulators who cannot forsee every crisis, and fail to enact game-changing curbs on the size of banks and the riskiest activities on Wall Street.

Consumer Watchdog
Consumer Watchdog
Providing an effective voice for American consumers in an era when special interests dominate public discourse, government and politics. Non-partisan.

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