By Steven Pearlstein
Wednesday, February 24, 2010; A08
It's been a year and a half since the collapse of Lehman Brothers, and you have to wonder how big a financial crisis we have to go through before we get the new regulatory apparatus in place to make sure it doesn't happen again.
There are many parties to thank for this stalemate: Liberal Democrats who insist that the only solution is to micromanage the financial services industry from Washington. Conservative Republicans who can't accept that their deregulation went too far and can't bear the thought of handing a legislative victory to President Obama. A financial services industry that says it supports regulatory reform in general but can't agree to any specific changes. And regulators, in denial about their own failures, who remain determined to preserve their power and influence.
Now, however, there appears to be a good chance for a breakthrough. By early next week, look for Sens. Chris Dodd of Connecticut and Bob Corker of Tennessee to unveil a creative bipartisan proposal that will hit all the right notes in terms of both policy and politics and will have the best shot at Senate passage. As Democratic chairman of the Senate banking committee, Dodd has shown the patience and persistence to keep at the task even after months of playing political rope-a-dope with industry lobbyists and Sen. Richard Shelby of Alabama, his Republican counterpart. And in deciding to pick up negotiations where Shelby left off, Corker has been a profile in courage these past few weeks in the face of social and political ostracization by some of his fellow Republicans.
Some credit also goes to Obama, whose decision to embrace a more populist critique of Wall Street in recent weeks has rattled financial markets and persuaded big banks to push for a compromise rather than leave a cloud of regulatory uncertainty hanging over their heads. Apparently nothing focuses the mind of a Wall Street banker so much as the prospect of being forced to shut down his proprietary trading desk.
Politically, the big sticking point has been the administration's proposal to create an independent agency to regulate all consumer loan products and prevent the kinds of abuses that led to the subprime mortgage debacle. For consumer groups, the new agency became a litmus test for whether the needs of ordinary Americans would be put on an equal footing with the needs of investors and fat-cat bankers.
For banks and other unregulated lenders, by contrast, the proposed consumer agency came to represent an unwarranted intrusion of government regulators into their business. Much like the "public option" in the fight over health-care reform, the consumer agency quickly assumed symbolic importance way beyond its practical significance. Lines were drawn in the political sand that both sides vowed never to cross.
The compromise hammered out between Dodd and Corker would establish a single regulator of federally chartered banks with a dual mission and an independent source of funding, based on my conversations with several key players. One division would promulgate and enforce rules to protect consumers; the other would fulfill the traditional role of supervising banks for safety and soundness. Supervisors from both divisions would participate in the periodic reviews of bank operations, and any conflicts between the two would be resolved by the head of the agency.
A more interesting and ultimately important issue concerns bank bailouts and the treatment of financial institutions considered too big or too interconnected to fail. Both the Bush and Obama administrations argued that these institutions should be identified ahead of time and regulated exclusively by the Federal Reserve, with higher capital requirements and an obligation to contribute to a bailout fund.
Although the House adopted that approach, senators are balking. Republican senators in particular are dissatisfied with the Fed and want to strip it of all responsibility for bank supervision. And a number of senators from both parties, unhappy about the recent bailouts, reject the idea that the government should protect any institution from going under, no matter how big or interconnected.
Dodd, Corker and Democratic Sen. Mark Warner of Virginia are putting the finishing touches on a plan reflecting these judgments. As they envision it, any time a big financial institution is threatened with insolvency, the government would be authorized to take it over and close it down in a bankruptcy-like process. The government could provide temporary loans to ensure an orderly liquidation process and prevent financial panic, but only to the extent that the loan would be repaid from proceeds of the sale of the bank's assets. Although insured depositors would be protected, creditors, counterparties and investors would all suffer losses.
What's likely to emerge from these still-ongoing discussions is a comprehensive regulatory reform bill that not only has the support of key sectors of the financial services industry, but also improves on the legislation passed last year by the House. In committee, Corker could find himself the lone Republican voting for the bill unless Shelby decides to reassert his rightful role as the Republican dealmaker. But my guess is that once the bill reaches the Senate floor, Republicans will face the difficult political choice of either embracing financial re-regulation and handing the president a victory or defending industry practices that even Wall Street is now unwilling to defend.