WASHINGTON – As President Barack Obama heads to New York City today to press for a major overhaul of financial rules, he faces stiff opposition by Wall Street to the toughest proposed regulatory crackdown since the Great Depression.
A Senate committee on Wednesday approved the final piece of the sweeping legislation – strict new oversight of the murky and unregulated market for complex financial derivatives. It is one of three significant provisions that rile Wall Street the most.
Also drawing fire from large financial firms and business groups are a proposed agency to protect consumers in the financial marketplace and a $50 billion fund, paid for in advance by the industry, to help cover the government’s costs should it need to seize and dismantle a large financial firm because its impending failure would threaten the economy.
In addition to limiting derivatives, the bill offered by Senate Agriculture Committee Chairman Blanche Lincoln, D-Ark., would also improve transparency of derivative trades.
The legislation was approved Wednesday on a 13-8 vote. Sen. Charles Grassley, R-Iowa, joined the panel’s 12 Democrats in supporting the measure.
Grassley’s defection suggests Republicans might be softening their opposition to the Obama administration’s financial regulatory overhaul.
Lincoln’s derivatives bill is expected to be incorporated into the broader regulatory legislation before it is taken up by the full Senate. The House passed similar legislation in December.
Obama is trying to ratchet up public support for reining in Wall Street as financial firms recover much more quickly from the deep recession than rest of the country. Reflecting optimism on Capitol Hill about a bipartisan deal, the president toned down his anti-Wall Street rhetoric Wednesday.
“We have to have a thriving financial sector,” Obama said on a CNBC interview. “But we also have to have basic rules of the road in place to make sure investors, consumers, shareholders, the economy as a whole are protected against excess.”
Still, Wall Street is battling aggressively against the legislation. Here’s a look at the three key areas of dispute:
Tough derivatives oversight
Derivatives get their name because they derive their value from something else, such as interest rates, currency exchange rates, mortgages or the price of corn or oil.
Credit default swaps and other derivatives are complex business contracts that typically serve as insurance against future market conditions.
But derivatives also can be used to bet on the performance of assets or markets, and that’s where the abuses took place that nearly crashed the world economy.
When the housing bubble popped, the derivatives market tied to mortgages crashed with it. Among Wall Street’s battered firms was American International Group Inc.
Regulators were largely unaware of the widespread exposure to the derivatives market by AIG and other firms. Although some derivatives are voluntarily traded on public exchanges, most are not, leaving prices and the volume of deals in the dark.
The overhaul legislation would require about 90 percent of derivatives to be traded on regulated exchanges and be approved by central clearinghouses. Those processes would ensure there was enough money backing up the deals and provide details about the contracts and their prices that make it harder to defraud investors.
Major banks, such as Goldman Sachs Inc., JPMorgan Chase & Co. and Bank of America Corp., have huge derivatives businesses and would be big losers if the new regulations took effect. The Senate proposal would require banks to spin off their derivatives businesses to subsidiaries.
A new consumer financial protection agency
A centerpiece of Obama’s regulatory overhaul proposal was a new Consumer Financial Protection Agency. The agency would take the rule-writing authority from the Federal Reserve and the power to examine banks and other financial firms for compliance from the Fed and other banking regulatory agencies.
The proposal has drawn criticism from banks and businesses, most notably the U.S. Chamber of Commerce.
Opponents said the agency would have too much power and too little oversight. They said its rules could limit the availability of credit to consumers and businesses and could endanger the fiscal health of institutions by crafting rules without input from banking regulators.
Lobbying from businesses and banks – along with opposition from existing regulators – led the House to scale back the agency’s powers.
Stiff opposition from Republicans led Senate Banking Committee Chairman Christopher Dodd, D-Conn., to make changes in his version of the legislation. Instead of a stand-alone agency, he would place it in the Fed, where it would still have an independent head and budget. Its powers otherwise would remain largely the same as originally envisioned.
A prepaid fund to dismantle large financial firms
The legislation also aims to prevent future bailouts by giving the government authority to seize and dismantle large firms that are on the brink of bankruptcy, should their failure threaten the economy.
The so-called resolution authority would resemble the power of the Federal Deposit Insurance Corp. to step in before a bank failure and shut it down in an orderly way or sell it to another financial institution.
Without such power to deal with nonbanking firms, the Federal and the Treasury had to concoct a series of loans to bail out AIG in 2008 amid fears that its bankruptcy could cripple the financial system.
New authority under the overhaul would allow an orderly shutdown of a large firm to avoid market chaos that could result from uncertainties about the bankruptcy process.
The House, trying to avoid sticking taxpayers with the costs of any shutdowns, proposed that large financial firms pay a total of $150 billion into a reserve fund in advance so it would be ready in case it was needed.
Dodd attempted to ease criticism by reducing the fund to $50 billion, but opponents remain skeptical. They prefer to have the government collect payments to cover the costs only after it starts to close a large firm.
Dodd and the administration have said they are prepared to adopt such a postpaid fund.