A short guide to financial regulatory reform.

Who's winning, who's losing, and why.
March 29 2010 7:02 PM

FinReg 101

A short guide to the hottest new policy debate (with the worst name) in Washington.

Passing health care reform makes any legislative task look easy. But it's still unclear what financial regulatory reform—or FinReg, as it's known inside the Beltway—will look like, whether it will have any teeth, and when it will pass.

The answers at this moment seem to be, respectively: complicated, no, and soon.

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This is all eerily familiar. The House has already passed its bill and is waiting for the full Senate to act. Senate Republicans are likely to extract concessions that House Democrats do not like. Powerful business lobbies are mobilizing their forces. Here, then, is a short history and quick summary of some of the major debates.

When the House passed its version of the bill in December, it did so with 223 Democrats and zero Republicans. Senate Democrats don't have the luxury of partisanship. With only 59 votes, they'll need at least one Republican defector to overcome an inevitable filibuster. (Because the bill doesn't directly affect the budget, the reconciliation route isn't an option.) The task of finding that vote falls to Sen. Chris Dodd, chairman of the banking committee. It's so far proved difficult. Talks with Sen. Richard Shelby, his GOP committee counterpart, collapsed. When Dodd and Sen. Bob Corker failed to reach an agreement, Dodd decided to go it alone and bring his own bill to the full Senate.

Although the bill offered by Dodd's House counterpart, Barney Frank, is in many ways tougher, the Dodd bill is probably a better road map for what the final policy will look like. But it's likely to be further tweaked—i.e., watered down—before it has enough votes to pass the Senate. Here are the most important components and how they're likely to change.

The Consumer Financial Protection Agency. If there's a place for Republicans to plant their flag, it's here. The CFPA would regulate all kinds of credit, from mortgages to credit cards to payday loans, with an eye toward keeping lenders from exploiting consumers. Dodd originally pushed for an independent agency—the idea being that autonomy from other federal agencies would allow the CFPA to be more consumer-friendly—but scrapped that idea after Shelby objected that it would be too powerful. The latest version of the bill would house the CFPA within the Federal Reserve. But it would maintain some measure of independence by having its own budget and a presidential appointee at the helm. Expect Republicans to chip away further at its independence before the bill passes.

Resolution authority. That's a fancy way of saying, "When and how can regulators intervene if they think a firm is going under?" The White House wants regulators—in many cases, the Fed—to deal with failing nonbank entities much like the FDIC currently deals with failing banks: The FDIC has broad leeway to intervene before a bank is even bankrupt. It can force the bank to change management and raise capital. If necessary, it can seize the bank. The Fed would have the same freedom to intervene with failing hedge funds and insurance providers, if Democrats have their way. Republicans would rather a firm be near-death before allowing regulators to intervene. The GOP is likely to win this one, as the Dodd bill already incorporates many of its changes.

"Too big to fail" provisions. The crucial fix is an insurance policy for the largest financial institutions, which would have to pay dues into a $50 billion fund. That fund would then be used to bail them out if they start to sink. One downside to the policy is that it identifies which banks are "too big to fail"—they're the ones contributing to the "too big to fail" fund—and would therefore be safer for investors. But supporters figure it's worth the tradeoff. Republicans also argue that this amounts to a bailout fund for banks—even though, as the last crisis proved, the alternative would be a taxpayer-funded bailout. Other provisions that would limit the size of banks have been all but scrapped. The "Volcker rule," which would require banks to keep investment funds separate from commercial deposits, remains, but Dodd seems skeptical that it will survive.

Simplified regulation. There are currently several agencies that can regulate banks: the Federal Reserve, the FDIC, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision. Dodd's bill would cut out the last of these. It would also limit the scope of the Fed to the largest banks and would put the FDIC in charge of smaller banks across the country.

Early warning system. A nine-member board chaired by the treasury secretary would be in charge of sounding the alarm if a firm was about to go under. The politics of whistle-blowing would be extremely complex—how does the board decide whether to act, potentially destroying a major corporation, or to hold back, potentially destroying the entire economy? Still, it's better than nothing.

Other issues. Democrats want to require that banks trade derivatives and other complex financial instruments through clearing houses. They're pushing for shareholder approval for executive compensation packages. They would also require that the originators of mortgage credit keep some of the risk, rather than selling all of it off. Republicans are resisting all of these measures.

None of this means anything, of course, without an administration to enforce it. As Paul Krugman puts it, "No system will work once President Palin gets to appoint the Secretary of the Treasury and the chairman of the Fed." That's one reason Democrats are selling FinReg as now or never. (Another reason is November.)

Of course, agencies do have the ability to act without congressional approval. They could raise capital and liquidity requirements for banks, for example. The reason they haven't yet is that it could make the credit crunch even worse, says Brookings Institution scholar Douglas Elliott. But if Dodd's bill falters in the Senate, renegade regulation may be the administration's only option.

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Christopher Beam is a writer living in Beijing.

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