In the wake of the financial crisis, Congress is weighing the biggest changes to banking regulation in decades. The chairmen of the Senate and House banking committees, Sen. Christopher Dodd, D-Conn., and Rep. Barney Frank, D-Mass., are rushing to meet President Obama's January 1 deadline for enactment. The bill would create an agency to protect consumers from unfair lending; consolidate oversight of banks and other financial institutions; and establish new powers to ensure that failing banks don't endanger the financial system. Here's a primer on the process.
What's going on with financial regulatory reform? I know that Dodd has a new plan and that Frank is expected to move his plan out of committee soon, but I still can't tell what the administration's plan is. Why so many plans?
Well, for starters, this re-regulation of finance is huge, so it is natural that everyone would want to drive the train. Primarily, though, the many approaches reflect a strategic decision by the Obama administration. Rather than come out with a fully formed plan and guide the negotiations, the president's advisers decided to let Congress work out the details.
But didn't Obama offer a comprehensive bill over the summer?
It wasn't a bill; it was called a "blueprint." It was sketchy in its details, and many of its ideas have been changed or abandoned. House and Senate Democratic leaders, for example, now say that regulation by the administration's Consumer Financial Protection Agency should be limited to the largest 10 percent of banks. Other fundamental matters were left unmentioned, such as the way to discourage big banks from taking on too much risk -- how, exactly, to avoid fostering banks that are "too big to fail" and thus take reckless risks because they believe that the government will bail them out. No plan has settled on how to avoid this problem.
Isn't it typical to start with a blueprint? Isn't that how President Reagan did tax reform in the 1980s?
Yes, but it's not typical to be as disengaged as the Obama administration seems to be this late in the game. The White House said all along that it wants to complete the reform process this year, and even though it has pushed Congress to vote on the legislation, it opposes some aspects of both chambers' bills. That rush apparently was at least partly responsible for a rift between Dodd and the top Republican on the Senate Banking Committee, Sen. Richard Shelby of Alabama.
Why did the White House proceed this way, without firm positions?
For reasons of style and necessity. On the style point, it should be clear from health care that in implementing his agenda, Obama seems to prefer leaving the details to Congress. His style simply differs from that of past presidents, who have led negotiations rather than let congressional leaders take charge. To cite Obama's predecessors, the Bush team was deeply involved in lining up votes and twisting arms to pass his 2001 tax cut; President Clinton did the same in ending Cold War trade restrictions on China. That doesn't seem to be how this White House likes to do things.
What about necessity -- why did the administration have to start out that way?
Because even as late as June, Obama's advisers hadn't decided what to do, and in many ways, they still haven't.
You've got to be kidding.
As with every phase of the financial crisis, the government was improvising, trying to stay ahead of events. Arguably, Obama had good reasons for moving forward with something on financial regulation, even if the proposal was incomplete. He had to send the message to the global financial system that there was a plan, some process, to avert a recurrence of the kind of crisis that took hold in 2008 and shut down bank lending. Five months after the inauguration, after an $787 billion stimulus plan, and after deciding that health care would be his focus in 2009, it just wasn't possible to re-design financial regulation in a few weeks. On the other hand, deliberating for months internally, with rumors and details leaking out, could have destabilized the markets.
Wasn't politics a big reason for the haste? Without some plan, Republicans would have spent the past five months complaining that "Obama is wasting time on socialist health care and neglecting financial reform."
Of course politics was a big factor. History will have to judge whether Obama's push on health care led him to neglect more-important matters. With or without health legislation, however, it would have been impossible for Obama to decide fundamental questions of financial regulatory reform so quickly. For one thing, the financial industry was unprepared and hadn't sorted out what it would and would not accept. The White House couldn't take a final stand on matters without getting the banks and other financial institutions on board. The months since June have really been a feeling-out process for both sides.
So banks are holding up this process?
That's too simplistic. In our system, where banks and other moneyed interests finance every congressional campaign, banks have a seat at the table. There are other considerations, but it would be silly to pretend that such a large industry has no role. As with health care, the Obama team needed time to determine which parts of the financial industry could kill the process and which parts could be co-opted. For example, after the House's hearings it became clear that smaller banks, with a presence in every congressional district, weren't willing to go along with the consumer protection agency proposal. Administration officials could see that the largest 10 percent of banks accounted for 80 percent of lending, so they let the bottom 90 percent off the hook. It took time to make this judgment, and there are many more to make.
Well, where is the process now? Isn't the House going to be voting on the Frank bill in a few weeks?
Obviously, the bill won't be finished this year, considering that the Senate plan was unveiled a week and a half ago and is fundamentally different from the House version. The question is whether the process is near the end or much closer to the beginning, and there are signs that it is much closer to the beginning.
Among the differences between the chambers' proposals, the Senate plan is predicated on a really big change--taking all bank regulation away from the Federal Reserve Board and creating a powerful agency to assume the Fed's role in managing the stability of the financial system, both domestically and internationally. Fed Chairman Ben Bernanke is against this, and so are Treasury Secretary Timothy Geithner and White House economics adviser Lawrence Summers. This conflict is too fundamental to sort out in routine conference negotiations. Other issues aren't as complicated -- whether to merge two small agencies or four, for example. But some other basic matters remain undecided.
Such as the whole point of financial regulation. Before the crisis, the government implicity guaranteed that it would do whatever was necessary to prevent the collapse of the financial system. Today, that guarantee is explicit, and it will be codified in this financial regulatory overhaul. The problem is, no one has decided how to guarantee the solvency of giant banks without encouraging the kinds of risky behavior that caused the crisis. How do you prevent the emergence of banks that are too big? There are ideas -- Dodd would use an exotic kind of bond to keep banks in line -- but no decisions. Likewise on derivatives, the privately traded securities that allowed insurance giant American International Group to almost wreck the global financial system. To sum up the House and Senate action on derivatives, the government is still in the early stages of determining how derivatives will be regulated.
When is this going to get done?
A bill could be enacted by June, but it is also easy to see action slipping past the fall 2010 election. Obama wants to get reform done to claim credit for Democrats, but Republican opposition is arguably as strong as it is on health care, and the GOP is confident that it will have larger numbers in 2011. The president was able to shorten the customary reform timetable when it came to health care, and perhaps he can do so on financial regulation as well. Big reforms usually take time, however -- Reagan embraced tax reform in 1984, but it was 1986 before it came to a vote. Ironically, as the financial system recovers, the pressure for reform lessens. Dodd, in a tough re-election fight, could be crucial if he seeks to finish action in time to impress voters. He might force a partisan vote this fall to get the issue off his plate, but that might hinder compromises in the final stages.
It sounds like I should bet on this taking a lot more time.
With big reforms, that's usually a good bet.
This article appears in the November 21, 2009 edition of National Journal Magazine Contents.
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