TOPICS > Economy

Financial Reform Overhaul on Fast Track to Passage

May 21, 2010 at 12:00 AM EDT
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A sweeping reform of the nation's financial regulatory system passed a key vote before the Senate late Thursday, fast-tracking a final vote on the overhauls. Judy Woodruff reports on the process to reconcile the House and Senate versions of the legislation.

JUDY WOODRUFF: Sweeping reform of the nation’s financial regulatory system moved to the fast track today. Democratic leaders met at the White House to plot their course in the wake of a key Senate vote last night.

Senator Chris Dodd and Congressman Barney Frank were upbeat as they emerged from their sit-down with the president. They will be in charge of merging the separate House and Senate bills.

REP. BARNEY FRANK, D-Mass. Financial Services Committee chairman: I understand the urgency for the financial stability of the country in getting this done quickly. Stability — knowing what’s going on is important. I think people can be pretty confident. I — it’s hard for me to think that this is going to take us more than a month.

JUDY WOODRUFF: That prediction was made possible after the Senate passed its version of financial reform last night 59-39. All but two Democrats voted yes, while all but four Republicans voted no.

The opponents included Wyoming Senator Mike Enzi, who warned of what’s to come.

SEN. MICHAEL B. ENZI, R-Wyo.: So, I want you to just understand how wide-ranging this bill is. This is going to get into everybody’s pockets. And I’m not talking about businesses. I’m talking about individuals. The dadgum government’s going to be in everybody’s pocket with this bill.

JUDY WOODRUFF: The Senate bill included provisions to deal with the problem of too big to fail by making it easier for the government to wind down failing companies; create a bureau inside the Federal Reserve to protect consumers of financial products, and, for the first time, institute federal oversight of derivatives, bets made on the future price of securities.

REP. NANCY PELOSI, D-Calif., speaker of the House: On this vote, the yeas are 223; the nays are 202. The bill is passed.

JUDY WOODRUFF: The House bill that passed last December was similar in many respects, but differed in others. For one thing, it would place the new regulator of consumer financial products outside the Federal Reserve. And, unlike the Senate bill, it would exempt auto dealers from that agency’s oversight.

On Thursday, President Obama hailed the progress on a main item of his domestic agenda.

U.S. PRESIDENT BARACK OBAMA: Good afternoon, everybody.

JUDY WOODRUFF: He said he will resist efforts to water down the final version of the bill during House-Senate negotiations.

BARACK OBAMA: There’s no doubt that during that time, the financial industry and their lobbyists will keep on fighting. But I will ensure that we arrive at a final product that is both effective and responsible.

Our goal is not to punish the banks, but to protect the larger economy and the American people from the kind of upheavals that we’ve seen in the past few years.

JUDY WOODRUFF: Still, major banks and business groups remain opposed to most of what’s in the overhaul bills.

David Hirschmann at the U.S. Chamber of Commerce made that clear today.

DAVID HIRSCHMANN, senior vice president, U.S. Chamber of Commerce: We’re concerned for three reasons. One, it perpetuates uncertainty at a time when we need more certainty. And you only have to look at what is happening in Greece to understand that.

Second, it impacts businesses that had nothing to do with this crisis and will restrain credit available to them. And, third, it fundamentally doesn’t modernize the regulatory structure that is now 80 years old and way overdue for a comprehensive update.

JUDY WOODRUFF: The final bill begins taking shape when House-Senate negotiations begin in earnest after Memorial Day.

And now to help us make sense of what’s in the legislation and how the final bill could affect consumers and businesses, we’re joined by two financial writers. Greg Ip is the U.S. economics editor for “The Economist” magazine. And Stacy-Marie Ishmael, she is a reporter for The Financial Times.

Thank you both. This is complicated legislation, so I’m going to ask you just to take — we’re going to bite off just a few pieces of it and talk about them.

First of all, the mechanism that gives the federal government the ability to deal with a big company that is about to fail, Greg Ip, how would that work?

GREG IP, U.S. economics editor, “The Economist”: Well, we already have a mechanism like that for dealing with banks. It’s called the Federal Deposit Insurance Corporation.

And, in fact, the FDIC closes banks almost every week, and yet depositors almost never notice, because the FDIC has the ability to pay them off while they go through this orderly process of closing down the bank.

The problem is that we don’t have a mechanism like that for companies that aren’t banks. So, if you go back to 2008, when Lehman Brothers failed, we had no choice but to let them go bankrupt. And that created all sorts of chaos. And, then, when American International Group came along, not wanting to repeat that experience, we had to bail them out and pay off all the creditors 100 cents on the dollar.

With this new mechanism, we can basically do with any kind of company, not just a bank, what we now do with banks. We can take over a company on the verge of failure, make sure that it closes in a fairly orderly process, while hopefully imposing enough losses on the people who invested in it that they will think twice before lending money to them in the first place.

JUDY WOODRUFF: Stacy-Marie Ishmael, what would you add? And would this prevent the kind of taxpayer rescues that we had — we had to implement, the government had to implement the year before last?

STACY-MARIE ISHMAEL, The Financial Times: Well, that is one of the interesting differences between the House and the Senate provision, in that the House vision of the bill would collect $150 billion from the major banks who this bill is designed to address to essentially prevent the government having to spend any money at all.

The Senate version doesn’t have that provision. But the spirit of the bill is such that taxpayers should be at least shielded from a fair amount of those kinds of aftereffects.

JUDY WOODRUFF: And — and it is believed this would prevent the kind of catastrophic failures we saw?

STACY-MARIE ISHMAEL: It would definitely, if they did happen, make them easier to deal with.

JUDY WOODRUFF: All right, I’m going to stay with you Stacy-Marie.

Another provision, creating a consumer protection agency, now, the Senate bill…


JUDY WOODRUFF: … would put it inside the Federal Reserve.

STACY-MARIE ISHMAEL: That’s correct.

The — this has actually been, on Wall Street, among lobbyists, and even in government, one of the most contentious provisions in the bill. There have been disagreements over, as you mentioned, whether that protection agency should sit within the Federal Reserve, whether it should be an independent agency, and also who would fall under the oversight of this particular new regulator.

JUDY WOODRUFF: And — and, Greg Ip, what about this, the fact that the two houses have a different provision, that the House provision has it outside the Federal Reserve?

GREG IP: Well, Barney Frank in the House has said that he would probably be willing to go along with what the Senate version is.

But I think the key point to keep in mind is that this agency, if it works as advertised, deals with one of the most serious regulatory failures we had coming into the crisis. One was that consumer protection just wasn’t a priority for a lot of the bank regulators. It will be the only thing that this agency does.

The other problem we had was that there was a lot of small companies, mortgage brokers, finance companies, which were regulated by the states. They didn’t actually meet the higher standards that banks had to. Hopefully, this agency having power over all those types of companies will bring everybody up to the same sort of standard of — of regulation.

JUDY WOODRUFF: All right, let me raise another piece of this legislation. And that is the $600 trillion, I guess, derivatives market. Now, these are the — these are the instruments trading on future outcomes.


JUDY WOODRUFF: What would the legislation do to that market?

GREG IP: Well, most people don’t even know that derivatives are out there and that they are being traded, that this huge market that allows people to take very large positions with very small amounts of money exists, except when something gets into trouble.

In 1998, we had it with Long-Term Capital Management, and then 2008, we had it again with AIG, which had large derivatives positions. And the problem is, is that they are so opaque and so large that a company can basically drag the entire financial system down with it if it gets into trouble.

So, the bill would deal with this in two ways. First of all, instead of allowing companies to basically only trade these in their own dealer rooms, where nobody can see them, they would have to trade them on exchanges, just the way you trade a stock on the New York Stock Exchange, where it would be transparent and visible.

And they would have to clear them through what we call central clearinghouses, which means they would have to put out more money, more collateral to make sure, if for some reason the banks failed, it wouldn’t pull the whole financial system down with it.

JUDY WOODRUFF: Stacy-Marie, what would you add to that, and especially the effect on consumers?

STACY-MARIE ISHMAEL: Well, I mean, the effect on consumers is one of the things that people often don’t appreciate, in the sense that the reason that a lot of people were able to have cheap mortgages and cheap credit had to do with banks, derivative positions. There is — it’s like a waterfall effect, in a sense.

So, there may not be a direct effect immediately, but what happens is, these — as — as Greg pointed out, when these things get regulated, they basically get less profitable for the banks that are involved in them, and trading these kinds of products are a huge chunk of banks’ profits.

And if banks are making less money, they may also be less inclined to then lend to consumers. So, that is something to look out for.

JUDY WOODRUFF: And there is this so-called Lincoln provision, the senator from Arkansas…

STACY-MARIE ISHMAEL: Yes, exactly, who — she…

JUDY WOODRUFF: … which would forbid — go ahead, yes.

STACY-MARIE ISHMAEL: Well, she would — she would prevent banks from having anything to do with derivatives at all, and in particular a certain class of derivatives those known as swaps.

Her provision would effectively say that if a bank wanted to have anything to do with swaps, they would have to move that unit into a subsidiary section that was walled off from the main banking operations.

JUDY WOODRUFF: And this is something that is, again, going to be negotiated in conference committee.


JUDY WOODRUFF: Stacy-Marie, staying with you, restrictions on banks, on how much capital they are required to keep on hand, whether they can trade in their own securities, so-called proprietary trading, tell us about that aspect.

STACY-MARIE ISHMAEL: Well, the proprietary — the proprietary trading section of the bill, it falls under, broadly speaking, what is known as the Volcker rule, because it was proposed by Paul Volcker.

And what would that would mandate is that banks would no longer be able to trade for their own book. Effectively, they would only be able to engage in activities that directly benefited their clients. It would also put restrictions on their ability to invest in hedge funds and private equity.

JUDY WOODRUFF: Greg, what — what else would you add in terms of what this would mean…

GREG IP: Well, I actually think is one aspect that really doesn’t affect most people very much. I don’t think that most customers of banks benefit from the fact that banks do a lot of proprietary trading or hedge funds and private equity and so forth.

Now, the Lincoln amendment, which goes much further, and says banks also cannot actually…


GREG IP: … operate derivatives desks, is another matter.

Now, Senator Lincoln’s view is that derivatives are dangerous and we shouldn’t allow taxpayer-supported institutions like banks to trade them. But there is another point of view that says, in fact, these derivatives are very valuable for helping banks control their risk, for helping them offer products that they otherwise could not.


GREG IP: And, moreover, if banks aren’t allowed to trade them, you just push them off into the shadows, where they are actually going to become more dangerous.

JUDY WOODRUFF: And, again, the thrust of this is to get that out in the open, and this will be negotiated.

What — what would you add, Stacy — excuse me — Stacy-Marie? There are also language in here regarding ratings agencies, regarding hedge funds.


On the ratings agencies, for anyone who is not familiar what with what they do, they effectively assign a rating that is a designation of creditworthiness. So, if a rating agency thinks something is creditworthy, they will give it the — what is basically a gold star on Wall Street.

And these agencies have come under a lot of criticism, because the products that they said were the most creditworthy, that had, you know, three gold stars, or AAA in the jargon, turned out not to be creditworthy at all. And so they would assign AAA ratings to things like products that had subprime mortgages in them.

And what these provisions are designed to do is reduce the power of these ratings agencies and also reduce the connections between the Wall Street banks and these agencies. There have been suggestions, for example, that some banks would shop around to try to get the most favorable rating, because it’s the banks themselves that pay the ratings agencies to apply ratings to their products.

JUDY WOODRUFF: All right, we are going leave there.

Much more to chew on, but we thank you both for helping us take a big bite out of it, Stacy-Marie Ishmael, Greg Ip.

GREG IP: Thank you.