The Road to Bipartisan Financial Reform

U.S. News speaks with Reps. Barney Frank and Spencer Bachus.

By + More

Fresh off their healthcare victory, Democrats in Congress are looking to leverage their momentum to push through an overhaul of the financial system. But like healthcare, financial regulation is a partisan minefield, and deep fault lines continue to emerge.

[See U.S. News's list of the Best Mutual Funds for 2010, and use our Mutual Fund Score to find the best investments for you.]

In December, the House of Representatives passed a financial reform bill on a contentious, party-line vote. The bill creates a consumer protection agency, slaps new guidelines on hedge funds and on derivatives trading, and outlines procedures for unwinding failed businesses. Now, with the Senate poised to consider a bill of its own, the stage is once again set for a divisive struggle.

[See Kanjorski Discusses Hedge Fund Regulation.]

Among the issues to be decided: What's the future of the "too big to fail" doctrine? How powerful should the Federal Reserve be? And should there be an independent consumer protection agency?

There are some early signs of compromise, but even the proposals billed as "middle of the road" have attracted fierce attacks. For instance, both the House and the Senate bills create a Consumer Financial Protection Agency that would regulate a wide swath of activities, including mortgage lending and credit card use. In the House bill, however, it's established as a stand-alone agency, whereas in the Senate's proposal, it's part of the Federal Reserve. By housing the agency in the Federal Reserve, Sen. Chris Dodd, a Connecticut Democrat, hoped to assuage the concerns of Republicans, many of whom would prefer that the agency not exist at all.

But Dodd's move alienated fellow Democrats, who have argued that the Fed has a proven track record of ignoring consumer protection. Rep. Barney Frank, the Massachusetts Democrat who is the architect of the House bill, has called the idea of making the agency part of the Fed "a bad joke."

Meanwhile, another delicate subject is the Democrats' proposals to wind down failing firms. The Senate bill, for instance, creates a $50 billion fund that would be used to dismantle large financial institutions that are on the brink of collapsing. This fund would not be financed by taxpayers. Instead, the money would come from fees collected in advance from the same institutions that could end up receiving emergency payouts from the fund.

Republicans have argued that it's essentially a bailout fund that will keep alive the notion that certain institutions are too big to fail. Democrats have countered that the money will not be used to prop failing companies up but instead to make sure that they can close their doors in an orderly fashion.

And even if the Democrats succeed in pushing reform through Congress, a number of other touchy issues are on the horizon. For instance, Congress has yet to firm up a plan for the future of Fannie Mae and Freddie Mac, the two housing giants that the government effectively nationalized during the recession.

To get a sense of what Democrats and Republicans are looking for in financial reform, U.S. News spoke with Frank, who chairs the House Financial Services Committee, and Rep. Spencer Bachus of Alabama, the ranking Republican on the committee. While the House is sidelined for the time being in the regulatory debate, it would need to approve whatever bill makes it out of the Senate before the new laws could take effect. Excerpts of their comments:

What measures would need to make it into the final bill in order for you to consider it a success?

Barney Frank: An independent consumer agency, risk retention on securitization, the ability for federal officials to pick and choose when an entity has failed, and we have to pay some debts to prevent chaos. The problem last year was the view that they either had to pay nothing, as in Lehman, or everything, as in AIG. [The federal government also needs] the mandate to monitor for systemic risk and the ability to step in and insist on changes for institutions that might be incurring systemic risk. And we need a guarantee that if an institution gets in over its head, it dies and we will put it down in an orderly fashion, using this ability to pay some of the debts but not all of the debts.

fiscal policy