U.S. Senate finally passes Financial Reform

It was a long time in coming, but in late May the US Senate finally agreed a financial reform package which now goes into a reconciliation process with the House bill passed in December. The May 19 vote on the approximately 1400 page bill was 59 to 39, with four Republicans (Collins, Snowe, Brown & Grassley) voting for the bill and two Democrats against (Cantwell and Feingold)

The key features of the Senate version include (source: The Financial Times, May 22/3, 2010)

• Curbs on abusive lending (mortgages and automobiles) through the creation of a Bureau of Consumer Protection within the Federal Reserve (not free standing and available for Congressional oversight, as in the House bill)
• The Volker rule forcing commercial banks out of proprietary trading (i.e. making bets with their own money, as opposed to trading on behalf of their clients) and separating them from hedge funds and private equity firms. No institution to grow via acquisition to hold more than 10 percent of US financial liabilities
• A one-time audit of the Fed, requiring the central bank to detail which institutions received financial help during the crisis
• The creation of a “financial stability oversight council” composed of the heads of the Treasury, Fed, SEC, FIDC, FHHA, comptroller of the currency and head of the new consumer financial protection bureau.
• A new set of rules on derivative trading, putting most of that trade on a public exchange, and obliging some of the bigger banks to spin off their trading in swaps or loss access to the Fed’s emergency lending window (this, the Blanche Lincoln amendment opposed by the industry and the White House)
• New powers to close failing financial institutions and sell off their assets, shifting the cost of bailouts from the taxpayer to asset holders (the bank’s creditors and shareholders): but no separate fund to help pay for liquidation as in the House bill, a fund financed by a fee on the banks.
• New oversight powers for the SEC in relation to the credit-rating agencies

Predictably, the compromises within the bill triggered criticism from both the advocates of stronger regulation and the advocates of less. The proposals on derivatives went too far for Sheila Bair (chair of the FDIC) and Paul Volker, even though he continues to press for bans on risky trading by banks using their own money.

• Blair: “it could destabilize banks and drive risk into unregulated parts of the financial sector.” (The Wall Street Journal, May 3, 2010)
• Volker: “commercial banks providing derivatives to customers ‘in the usual course of a banking relationship’ shouldn’t be banned from that practice.’ (The Washington Post, May 8, 2010)

The proposals did not go far enough for people like Robert Reich, Arianna Huffington or Simon Johnson. The general view of the legislation from mainline liberal commentators was that it was an opportunity missed. “Wall Street’s Victory Lap” was how Simon Johnson characterized it (The Huffington Post, May 26, 2010).

• He recently argued convincingly that “the constraints on size, leverage and activity could have been much stronger in the Senate bill (and presumably in the final legislation)” if the Brown-Kaufmann amendment had passed. It didn’t pass. The big banks will not be broken up. The White House didn’t press for that: and not because the White House is foolish/corrupt. But because “our top policymakers are convinced that what is good for the biggest and most dangerous element on Wall Street is good for the American economy….cultural capture in its purest and most extreme form”. (The Huffington Post, May 31, 2010, at www.huffingtonpost.com/simon–johnson/the-consensus-on-big–bank_b_594980.html)

• Robert Reich is equally pessimistic. “The Finance Bill Won’t Save Us.”  “The Senate rejected an amendment that would have broken up the biggest banks by imposing caps on the deposits they could hold and their capital assets.”  The bill preferred regulation to capping. And it did not effectively resurrect the Glass-Steagall Act forcing banks to separate commercial banking from investment banking (The Huffington Post, May 25, 2010)

And all this before the merging of the two bills! So there are things to watch for: the tightness of regulations over derivatives; the way “too big to fail” is avoided; the extent to which consumer protection is strengthened….the degree to which Wall Street lobbying is pushed back, intense though that lobbying now is. (For the details on the lobbying exercise by the banks, see M.B.Pell & Joe Eaton, Five Lobbyists for Each Member of Congress on Financial Reforms, Center for Public Integrity, May 21, 20-10, available at http://www.publicintegrity.org/articles/entry/2096/)

David Coates holds the Worrell Chair in Anglo-American Studies at Wake Forest University. He is the author of Answering Back: Liberal Responses to Conservative Arguments, New York: Continuum Books, 2010.

He writes here in a personal capacity.

This entry was posted on Tuesday, June 1st, 2010 at 4:49 pm, was written by David Coates, and is filed under Uncategorized. You can leave a response, or trackback from your own site.