It’s 1,400 pages long (about 200 pages longer than the Bible), has taken months to compile, contains a slew of amendments already — and raises more questions than it answers.
The massive overhaul of laws governing the financial industry passed the Senate Thursday night. But even if the bill is reconciled with a somewhat different House version and signed into law, it leaves many contentious issues for regulators to sort out.
And it raises the question of whether the Securities and Exchange Commission, whose track record has been shaky at best as a Wall Street watchdog, is up to the task of overseeing a far wider swath of the industry.
The drawn-out Senate debate has covered a wide range of issues — everything from the trading of risky derivatives to consumer protection on car loans — many of which have exposed fault lines within the Democratic majority.
In a effort to reach consensus, some of the most contentious issues have been left for regulators to sort out — if and when the bill becomes law.
“Each of the amendments that have been proposed for consideration creates a ripple of questions on how it will be implemented or realized,” said David Berenbaum, chief program officer at the National Community Reinvestment Coalition. “That either will be addressed through changes to the wording or through the development of regulatory standards.
Take the so-called “Volcker rule," named for the former Fed chairman who proposed it, designed to limit banks from making risky trades with depositors’ money. Democrats have so far maintained tough guidelines for regulators to apply; but the bill is short on the specifics of how the rule would work. The rule was eventually removed from the bill that passed.
“What the White House and Wall Street, actually, are jointly seeking is that the Volcker rule be legislated in a way that allows the regulators a lot of running room in terms of how they draft how it works,” said Roger Altman, an investment banker who served in the Clinton Treasury. ”But I think there's some pretty considerable agreement that some form of it will be in the bill."
Then there’s the debate over what to do about derivatives, the often complex financial instruments designed to manage risk that backfired spectacularly during the mortgage meltdown. One controversial amendment would force banks to spin off their derivatives operations, but it’s unclear how the divestment of those operations would proceed. A compromise delaying implementation of the measure for two years failed Wednesday.
Another potential unknown is what the new consumer protection agency would control. Supporters argue that financial regulators dropped the ball during the housing collapse and that consumers need a single agency defending their interests. But opponents warn that those interests need to be weighed against the need to maintain a strong financial system to provide the credit needed to sustain a still-fragile economic recovery.
“The consumer financial protection board is going to be a new political bureaucracy, overriding safety and soundness regulation," said Sen. Kit Bond, R-Mo. “It could be a disaster for community banks.”
Proponents of the sweeping reform package argue that the financial Panic of 2008 demonstrated the need to overhaul a system of financial regulations that just has not kept up with the dizzying pace of innovation and expansion of the financial services industry. Doing so, they argue, will not only protect taxpayers from the cost of cleaning up another financial meltdown; it will help strengthen Wall Street, too.
“I think the bill will be a good bill all the way around,” said Altman. “Meaning that it'll be good for the country and that it will also be good for Wall Street in the sense that it will ultimately result in a sounder and healthier Wall Street.”
The massive bill includes a number of measures. It would create a new nine-member council of regulators with new powers to identify and head off potential financial crises before they engulf the markets and the economy. Hedge funds and credit rating agencies would be subject to new oversight. Banks that create risky securities would be required to hold some of them on their books. The bill would create an ‘orderly liquidation’ process for big, failing banks.
The Senate bill, if approved, would have to be merged with a separate package approved by the House in December. The need to reconcile the various provisions has forced lawmakers to paint the new rules in broad strokes and defer specific rulemaking to regulators.
It remains to be seen whether the regulators will be up to the task. For example, the new law would give the Securities and Exchange commission clearer authority to deal with hedge funds. But it’s not at all clear whether the commission has the capacity to tackle the job. In its current form, the bill “sets up the SEC for failure," according to former SEC chairman Harvey Pitt.
“The SEC would be getting authority over 11,000 additional hedge funds,” he said. “You also have in the House bill private venture, private equity firms and the like. And the SEC does not have the ability or the manpower to examine those and make certain that those people are complying with the laws.”
The new law could have other unintended consequences. One could be to simply send investors looking for a way around the new regulations, moving more capital to the so-called “shadow” banking system of entities that fall outside the reach of financial regulations.
“Anybody who thinks they're not on the hook for what happens in the shadow banking system when it involves systemic risk is fooling themselves,” said Stephen Crawford, former co-president of Morgan Stanley and now a partner at Centerview Partners. “We've demonstrated that beyond a doubt in the last crisis.”
Republican senators also argue that the bill fails to address one of the biggest ongoing bailouts weighing on taxpayers and the financial system: the multibillion-dollar losses being generated by government-controlled mortgage giants Fannie Mae and Freddie Mac.
So far, the government has plowed over $100 billion into the two companies to keep them afloat in an open-ended bailout that began with their near-collapse in 2008. Fannie Mae and Freddie Mac buy mortgages from lenders and sell them to investors, providing home buyers with access to credit.
With private mortgage financing sharply curtailed since the housing bust, the two companies are a critical lifeline for the housing industry. They currently own or guarantee roughly half of all U.S. mortgages.
Unless they are restructured, the companies are expected to continue to require billions of dollars of tax dollars to stay afloat.
“There were amendments on the floor to bring about an orderly resolution of Fannie and Freddie to get them off of the taxpayers' credit card and get them away from the trough on which they've been feeding," said Bond. "Those were overwhelmingly defeated.”
Even as it remains unclear what impact the bill would have for taxpayers and consumers, bankers have reason to feel just as uncertain about the final impact on the industry’s bottom line. And no matter what the new regulations say, bankers face the prospect of lower profits over the long term.
After the financial crisis, the Fed flooded the system with cheap money, expanding the "spreads," or profits, earned by bankers. At some point, as rates begin rising again, bank profits could get squeezed.
“The banks have made a boatload of money over the last 18 months," said money manager Gary Kaminsky. "They’ve had a free ride here, and that's going to end soon. The earnings that have been created out of this are at the top of the peak right now. You're not going to see them get any better."
