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.
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.
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.
Does the House bill that was passed in December—the one in which the CFPA is a stand-alone agency—go far enough in the area of consumer protection?
BF: With the bill we have, there's only one weakness, and that is the total exemption for auto dealers. I regretted that. Auto dealer financing is totally exempted. I thought that was a mistake; I lost that vote. Otherwise, the Consumer [Financial] Protection Agency is fully operational with enforcement powers.
Do you expect financial regulation to get support from Republicans?
BF: In the House? No. Why would they change their minds? They voted against it. I think there are individual Republicans who would like to be supportive, but they are basically dominated by the Republican Study Committee, by the right wing. And as far as the Senate is concerned, I think the Republicans are starting to feel the heat there. One thing has changed: When we debated our bill, it was overshadowed by healthcare, so the public wasn't really weighing in that much. Now this is going be the No. 1 issue when the Senate does it, and the public is going to weigh in. And I think that's going to help us toughen the bill.
Will the momentum from passing healthcare help with financial regulation?
BF: A little bit, yes. But mostly it's the absence of healthcare as a blocking issue that's going to help us here.
What would a financial reform bill need to look like in order to get bipartisan support?
Spencer Bachus: We would need to address "too big to fail." That is critically important. And I don't think we're there yet. At the press conference at the White House, both Senator Dodd and Chairman Frank said they had ended too big to fail, but then they provide a bailout fund of $50 billion, which is a reduction from what the House had proposed, but it's still a bailout fund. … Could we have a repeat of AIG? And once you have a bailout fund, you can always increase that. It may start at $50 billion, but you have a tax in place. So we would not want a bailout fund. And we really want to end too big to fail. I think too big to fail undermines our sense of fairness and of equal opportunity or equality. America is built around the freedom to succeed or to fail. And I think it not only undermines market discipline—and there's been a lot of talk that "too big to fail" undermines market discipline, which it does—but it also contributes to a perception on the part of the public that there's no justice or fairness. And I think it undermines our entire faith in government. I think you see that in the Tea Party movement.
Are you concerned that the Democrats will push through a bill in a party-line vote?
SB: What I do fear the Democrats will do is they'll … try to make a bill so onerous that they don't get Republican support, and then they [will say] that Republicans did not want financial regulatory reform, which we very much want. We simply don't want it done badly. If we get a bipartisan bill, it shows us that they seriously want regulatory reform. If we get a bill that has no Republican support, I think that's just a political ploy on their part to try to shift attention away from their failures with healthcare, where they did nothing to bring down the cost, or with energy legislation, where they refused to go with nuclear power and some other things that would help solve our dependency.
How would you go about handling Fannie Mae and Freddie Mac?
SB: I would start reducing a percentage each year of the home mortgages that they hold. They hold $5 trillion worth of mortgages right now—a tremendous number or mortgages. Right now, taxpayers own 80 percent of Fannie and Freddie. And we've explicitly guaranteed—and I'm not for backing out of that—$5 trillion in mortgages that they've purchased. And that would be my first thing. I would start reducing that by a certain percentage each year. ... Over the last 40 years, we've crowded out the private market. And America's about competition.