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Wall Street Reform Clears Final Hurdle

by Ryan Grim

Nearly two years after major banks brought the global financial system to the brink of collapse, triggering a steep economic decline and crisis-levels of unemployment, Congress cleared the final hurdle to enacting a Wall Street reform package, passing a decisive cloture vote 60-39, with only three Republicans joining every Democrat (but one). Now, the bill heads to a final vote at 2 p.m. before being signed into law by President Obama.

The bill became stronger as the nation's focus moved from health care to Wall Street reform and became tougher still as the debate was held in the open on the Senate floor and during televised conference committee negotiations. Bank lobbyists were able to beat back the most serious threats to their business model, but enough significant reforms remain to earn the opposition of the American Bankers Association and other Wall Street titans.

When Democrats last reformed the financial sector in the midst of the Great Depression, they had several advantages that today's party lacks: A Republican Party divided and willing to work with a popular president, a banking sector so devastated it had little ability to wage political combat and Senate majorities that made a GOP filibuster effectively impossible.

This time around, Congress bailed out Wall Street, protecting the largest firms from collapse, which enabled them to lobby hard against reform, spending over a million dollars a day. Wall Street has become extremely sophisticated at lobbying, relying on community banks, auto dealers and small companies who use derivatives to hedge risk as the face of their opposition.

The effort suffered from the administration's hesitation to embrace an agenda that would genuinely remake Wall Street. A provision, for instance, offered by Democratic Senators Ted Kaufman of Delaware and Sherrod Brown of Ohio would have forced the nation's megabanks to shrink. "If enacted, Brown-Kaufman would have broken up the six biggest banks in America," a senior Treasury official told New York magazine's John Heilemann. "If we'd been for it, it probably would have happened. But we weren't, so it didn't."

Despite the obstacles, some major reforms will be put in place by the bill and new authorities granted to regulators could -- depending on whether that authority is acted on -- reshape the financial industry. The bill creates a consumer financial protection entity over the strenuous objections of the GOP and Wall Street, brings serious reform to derivatives trading, gives regulators the authority to break up major banks that are deemed a threat to the system, authorizes a broad audit of the Federal Reserve, largely bars banks from trading taxpayer money for their own profit and bans many of the deceptive mortgage lending practices that fueled the housing bubble.

"It is a good step towards fixing some of the worst practices, most notably by creating the consumer protection bureau," said Dean Baker, an economist with the liberal-leaning Center for Economic Policy and Research. "However, this bill does not fundamentally change the way Wall Street does business. These guys got off incredibly easy for the enormous damage they did the country."

The Consumer Financial Protection Bureau will have an independent director and independent authority to write and enforce rules barring unfair and deceptive financial practices. The CFPB will be housed within the Federal Reserve, but the central bank has no authority to override the bureau's actions. A council of regulators, however, sits above the CFPB and can veto rules it writes, though it must do so with a two-thirds vote and by demonstrating that the rule presents a systemic risk to the financial system. Auto dealers, however, managed to buy themselves an exemption from the bureau's regulatory scope.

"A year ago, it looked like we'd get a bill written by the industry that just protected the industry from itself, and only from the exact practices that caused the financial crisis," said Rep. Brad Miller (D-N.C.), a member of the Financial Services Committee who was battling subprime lenders long before the crisis. "This bill protects us from them, not just them from themselves. There are strong consumer protections that most people never thought we'd get."

The unsung hero of the financial reform debate may be Arkansas Lt. Gov. Bill Halter, whose union-fueled primary challenge of Sen. Blanche Lincoln prodded the chairman of the Agriculture Committee to write derivatives reform legislation tougher than anything being considered at the time.

"Organized labor just flushed $10 million of their members' money down the toilet on a pointless exercise," a senior White House aide told Politico's Ben Smith the night of Halter's primary defeat. Though the swaps package was weakened in conference committee, significant pieces of it remain that will cost Wall Street billions, money that will be redirected into the real economy.

A team of Goldman Sachs analysts predicted in a Tuesday research note that the legislation will annually cost Bank of America about $4.4 billion, Citi about $3.7 billion, JPMorgan about $5.3 billion, Morgan Stanley about $900 million, and Wells Fargo about $2.2 billion. It would be hard to find a more lucrative investment that Big Labor could have made.

The bill grants broad new authorities to the Commodity Futures Trading Commission, led by Gary Gensler, the administration's fiercest champion of reform. "Few have talked about it, but the real winner here is the CFTC. Under Gary Gensler, it has perhaps become one of the most reform minded and pro-consumer regulators in Washington. Not only did it get the lion's share of authority over derivatives, but it also gained additional authority to police fraud, manipulation and abuse, to place hard limits on speculation in commodity derivatives and require foreign exchanges that do business here to register," said Jim Collura of the New England Fuel Institute, who led a coalition of derivatives users who backed reform. "The next big battle will be the rulemaking process."

Perhaps most significantly, the law will limit the total amount of derivatives speculation a single bank can engage in, aimed at preventing a run-up in food or energy prices. In 2008, Goldman Sachs and other swaps traders drove the price of wheat to levels that caused starvation around the globe. Oil prices similarly skyrocketed as a result of speculation. Lincoln's reforms will restrict the activity that led to the soaring prices and should, said Greenberger, bring down food and energy prices around the globe. "That would constrain the ability of Goldman and Morgan to lay off these commodity index bets because they will bump up against the speculation limits. That means fewer bets will be placed and that theoretically... will lead to reduction of the price of energy and food staples," said Michael Greenberger, a professor at the University of Maryland School of Law and a former Director of Trading and Markets at the CFTC. "When you add to that that [the] swaps market is going to have to be cleared and exchange-traded, it's going to be a much more transparent market. Regulators can watch it and see what its impact is on the pricing mechanisms."

Lincoln's bill also requires banks to spin off swaps operations that trade in food and energy and separately capitalize them, a reform that aims to prevent one element of a bank from bringing down the entire institution.

The bill restricts the amount of trading a bank can do with taxpayer-backed funds, a reform known as the Volcker Rule. A last-minute compromise allows banks to trade three percent of such capital, but regulators have authority to restrict such trading if it appears to be purely speculative or poses a risk to the bank.

When the Volcker Rule -- named for former Fed chairman Paul Volcker -- was first introduced, it was declared dead on arrival by Washington pundits. Bank lobbyists threw everything they had at it and managed to block it from getting a vote on the Senate floor. But the measure's backers, Sens. Jeff Merkley (D-Ore.) and Carl Levin (D-Mich.), managed to revive it in the televised conference committee negotiations, the place where bills are normally watered down in secret.

The final bill also includes strict new rules on mortgage lending which banks say -- quite accurately -- will make brokering such loans less profitable. The law puts an end to "liar loans" that require no documentation of ability to repay the loan. It bans so-called "steering payments," handed to brokers who persuaded borrowers to take out more expensive loans than the ones they qualified for. And it prevents banks from charging draconian repayment penalties, provisions that were written into loans to lock a consumer into debt.

"I've fought an uphill battle against predatory mortgage lending the whole time I've been in Congress, and the bill includes almost everything I've fought for. I'm not going to let anybody lick the red off my candy because the bill could have been stronger," said Miller.

There are also lower-profile reforms that could have dramatic consequences in the future, such as the provision to authorize a broad audit of the Federal Reserve and mandate unprecedented disclosure of Fed lending. Another little-discussed provision requires American companies to disclose payments they make to foreign governments in exchange for access to resources. "This proposal is a great lever to support more transparency and healthier governance in poor countries," said Bono, co-founder of the anti-poverty group ONE, in a statement. "It will empower activists, media and good-governance watchdogs, both south of the equator and north, to ensure the continent's vast riches end up in service of its people, not lining the pocket of some kleptocrat."

The fight is far from over. The bill relies on financial regulators to study nearly 70 proposals and issue at least 200 new rules, according the Financial Services Roundtable, a lobby group for large financial firms, and a July 9 memo by Davis Polk & Wardwell LLP, one of the nation's biggest law firms. Davis Polk only counted those rules explicitly mandated for adoption in the bill, meaning the 200-plus number is likely a significant underestimate. How those rules are written, who writes them and how they're enforced will dictate the success or failure of the reform enterprise.

Perhaps the biggest disappointment for reformers is that the bill leaves in place the major banks that caused the crisis. The largest banks have grown larger under Obama's watch. Banks will still be able to speculate in the riskiest kinds of derivatives and invest in hedge funds and private equity funds. Depending on what regulators decide, they may not be required to hold much more capital to protect against losses than before the crisis, since neither a number nor a formula was specified in the bill. They may still continue to lever up their investments, imitating a practice of the fraud-inflated housing boom in which some investment firms used $1 to back up every $30 in investments and bets.

Bank of America, JPMorgan Chase, Citigroup, Wells Fargo, Goldman Sachs and Morgan Stanley -- the nation's six biggest bank holding companies by assets -- collectively hold more than $9.4 trillion in assets, according to their most recent quarterly filings with the Federal Reserve, a figure equivalent to two-thirds of the nation's total economic output last year, according to International Monetary Fund figures. It's also greater than the 2009 output of every other nation in the world.

An amendment championed by Rep. Paul Kanjorski (D-Pa.), however, gives federal regulators the power to break up big banks if they pose a "grave risk" to the financial system.

"The Federal Reserve is in the hot seat on this issue -- and it needs 7 out of the 10 members of the new systemic risk council to agree to any action. But for the first time someone at the federal level must make a determination regarding whether an individual firm poses system risk," says Simon Johnson, an economist who writes for HuffPost and the New York Times.

If regulators don't act on the authority granted them by the Kanjorski amendment, major banks will continue to represent a threat to the system. The heads of at least six regional Federal Reserve banks have criticized the bill for failing to enact what Obama's top economic adviser, Lawrence Summers, has said is the administration's "central objective" in reforming the financial system -- ending the perception that some financial firms are "Too Big To Fail".

Regional Fed chiefs from Dallas, St. Louis, Kansas City, Philadelphia, Richmond, and Minneapolis have all either doubted the bill's ability to end TBTF, criticized it for its perceived ineffectiveness, or simply said that bailouts are inevitable when it comes to such banks.

Though the banks survived this round, said Greenberger, they may not survive the next. We are not out of the woods yet as to the recession," he said. "I believe there will be a double-dip [recession] and I think when there is a double dip there will be more outcry over the conduct that led to this problem. The double dip will likely go right back to looking at what caused the problems to begin with, and to the extent that there are shortcomings in the legislation, I think it can be fixed when Congress takes another look and if the American people are agitated by further disastrous implications for the American economy."

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