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
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
"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
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
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
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
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."