As Congress this week inches toward a new set of rules to avert another global financial collapse, it is focused on two conflicting goals: reforming the banking system to protect consumers while still giving lenders the freedom to take risks.
So far the score looks like: Bankers 1, Consumers 0.
More than a year after a wave of risky mortgage bets brought Wall Street to its knees, banks and other financial institutions are still playing by the same rules that got them into the mess.
Reforming the sprawling financial regulatory system — a patchwork of federal agencies and state commissions — is a tall task under the best of circumstances. It’s even tougher with Congress already polarized over the health care debate, an economy on a wobbly path to recovery, banks facing a wave of foreclosures and households licking their wounds from $7 trillion in lost home equity and near double-digit unemployment.
Proponents of comprehensive regulatory reform hope for sweeping measures to protect consumers from predatory lending, rein in high-stakes Wall Street trading in arcane derivatives, boost capital requirements for banks that want to bet big with depositors' money and spread some regulatory sunshine on the dark pools of the “shadow banking system” that caught regulators flat-footed when the market spiraled into the abyss in the fall of 2008.
“We cannot afford to let the status quo continue,” Sheila Bair, head of the Federal Deposit Insurance Corp., told a meeting of business economists in Washington.
The final law is still in doubt. Sen. Christopher Dodd, D-Conn., has pressed for reform during a year of intensely partisan bickering. On Friday, Dodd — a lame duck who announced his retirement after disclosures that he accepted favorable terms from subprime lender Countrywide Financial — claimed that the Senate Banking Committee he chairs was “days away” from wrapping up a bill.
Any resolution faces a major political hurdle that has drawn the most public attention: a proposal to create a new agency to protect consumers from predatory lending and other abusive financial practices. While the "systemic risks" to the financial system may represent a bigger threat in dollar terms, voters might be more focused on the consumer impact.
Dodd said that’s not hard to understand.
“The subject matter of derivatives and swaps and the issue of systemic risk and too-big-to- fail seem somewhat removed from the general public,” he told CNBC after the Senate compromise was reached. “Watching my credit card go to 32 percent rates and huge fees, watching prepayment penalties on mortgages, these are things that millions of people understand.”
The details of the new consumer protection agency have become a major sticking point.
After insisting for months that any new consumer protection body had to be an independent, “standalone” agency, Dodd recently championed a compromise that would embed the agency within the Federal Reserve. (That proposal has yet to win committee approval.)
Critics of the idea of turning over consumer protection to the Fed argue that the central bank badly stumbled in applying its existing consumer protection laws to clamp down on bad mortgage lending during the housing bubble. Simultaneously protecting bankers and consumers, they argue, is an inherent conflict of interest.
But the idea of a new, standalone agency has met fierce resistance from lenders, who have so far succeeded in gluing the new regulator to the agency created 100 years ago to maintain the soundness of the banking system — the Fed.
Still, some consumer advocacy groups argue that where the agency is housed matters less than the powers it brings to the task. They argue that the critical elements required to protect consumers from heavy-handed, profit-minded lenders include an administrator appointed by the White House; a separate operating budget, funded by bank fees and not subject to congressional approval or rejection; broad authority to write rules governing a variety of financial products from insurance to credit cards; and tough, independent enforcement powers.
The banking industry initially lobbied hard to make sure that any new consumer protections were housed within existing bank regulators, such as the Office of the Controller of the Currency or the FDIC.
Analysts who have followed the turf war say the latest proposal gives bankers most of what they wanted.
“This is a bill the industry will love,” said Greg Valliere, chief policy strategist for Soleil Securities.
There is still strong support among consumer advocates for a tough, independent financial regulator tasked with the sole mission of protecting consumers. The latest compromise proposal drew a chilly response from supporters of a standalone agency.
"It's got to be a joke," said Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee, when assessing the Senate proposal to add consumer protection to the Fed’s mandate.
The White House, which has also pushed for a standalone consumer protection agency, said last week it is more concerned with ensuring that the new body has the tools it needs to act independently.
The administration's backpedaling may have to do with a new calculation on how best to exert influence over the new consumer protection regime.
That’s because the Obama administration could secure more influence over a Fed-based consumer protection agency now that the White House has a third vacancy to fill on the seven-member Federal Reserve Board. Last week Fed Vice Chairman Donald Kohn announced he was stepping down, adding to two existing open seats.
Other open appointments offer the White House additional opportunities to shift the course of financial regulatory policy. In August, John Dugan will end his term as comptroller of the currency, the chief regulator for most of the nation's largest banks.
When complaints of predatory mortgage lending began rising among state regulators in the mid-2000s, the OCC steadfastly opposed their efforts to police national banks. The OCC's policy, known as “pre-emption,” asserted that federal supervision of national banks trumped state laws.
State regulators have pressed that issue as far as the Supreme Court, arguing that they should be free to act without federal restraints because they often see consumer lending problems sooner than federal authorities do.
But bankers have successfully kept state regulators at bay, arguing that having to comply with dozens of different sets of rules would increase costs to consumers.
Without stronger efforts by legislators and regulators who have consumers' interests at heart, the match could go to the banks.