Path to passage

President Obama's financial overhaul plan wouldn't get great odds from Las Vegas bookmakers. Even the president himself has cast his sweeping revamp of bank and other financial firm oversight as a dark horse.

"This will not be easy," he said as he unveiled it June 17 in the East Room of the White House before a crowd of senior lawmakers, administration officials, economists, lobbyists and union and consumer activists.

Alluding to the library of failed and forgotten financial overhaul proposals now gathering dust on bookshelves across Washington, Obama lamented the missed opportunities of the past. "We know that this recession is not the result of one failure, but of many. And many of the toughest challenges we face are the product of a cascade of mistakes and missed opportunities which took place over the course of decades."

Continue reading below

Sure enough, the same industry forces that have protected the status quo of turf-conscious federal agencies and regulatory loopholes were trying to radically alter key provisions even before Obama stepped to the dais.

But although conventional wisdom mandates a discounting of the chance for Obama's financial reform, Obama, Treasury Secretary Timothy Geithner, National Economic Council Director Larry Summers and the other authors of the proposed regulatory overhaul appear anything but resigned to failure. They act like this thing has a shot.

Outside the administration, few are ready to bet that Obama will achieve quick passage with the entire package intact. But they aren't dismissing chances that major portions could be enacted in fairly short order.

Indeed, even past defenders of the status quo acknowledge the recession was brought on by regulatory failings and industry recklessness and an overhaul is necessary. "Regulatory reform is badly needed and that Congress should move this year to adopt such reforms," said American Bankers Association President Edward Yingling.

The Financial Services Roundtable, a trade group for the 100 largest financial firms, urged Congress to pass corrective legislation by the end of the year. "It is important to strengthen the system to protect the consumer, the industry and the economy," said Steve Bartlett, roundtable president.

Such endorsements are more than empty words, says David Katz, financial markets partner at Orrick, Herrington & Sutcliffe LLP. The severity of the downturn and the possibility that things could get worse will force Congress to make a serious attempt at passage. "What would get this moving is fear of another crisis hitting while Congress was letting a viable proposal die on the vine," Katz says.

Congress is already bogged down with healthcare reform and climate-change legislation and its ability to move another controversial bill would seemingly be nil. But chances for financial overhaul could actually increase if those other bills stall, if only because lawmakers will need something to work on.

And Congress can move big bills quickly if the pressure's on. Jim Wheeler, a Bryan Cave LLP partner specializing in financial institutions and acquisitions, noted that recent Congresses have enacted complicated Sarbanes-Oxley accounting changes and the unprecedented $700 billion Troubled Asset Relief Program when they had a crisis at their backs. Financial overhaul could have similar momentum, he says.

Former Republican Rep. Michael Oxley of Ohio, a co-author of the Sarbanes-Oxley law, said in a televised interview last week that legislation is likely. Overall, the Obama plan "goes in the right direction," he said, adding that it builds on a plan put forth in the previous administration by then-Treasury Secretary Henry Paulson.

Oxley said it's too early to tell how much Republican support the Obama plan will generate, but he wagered it will be enough to pass. "Reformers have the wind at their backs ... at the end of the day something will pass but not without plenty of infighting in between."

The centerpiece of the plan would seemingly generate enough opposition to threaten the bill. Obama is calling for increased oversight of systemic risk by a new council of regulators, with the Federal Reserve Board exercising broad new powers. Many in Congress are resisting the expansion of the Fed's powers. "That's going to be a tussle between the administration and Congress," says Martin Baily, senior fellow at the Brookings Institution. "Many in Congress would like to see the Fed's powers reined in."

But realistic alternatives have not been forthcoming from the Fed's opponents. In a briefing with reporters last week, Summers said responsibility for acting on systemic concerns ultimately must rest with one entity and the Fed is the only viable option. "Collective responsibility is too often no responsibility," he said. "Those with a different view should either justify collective responsibility or suggest an alternative."

At a Senate Banking Committee hearing the next day, lawmakers criticized the proposals for increased Federal Reserve authority but none offered options beyond the unhelpful suggestion to "start from scratch."

So confident is the administration in the Fed's ultimate coronation that it suggested returning power the central bank lost a decade ago, by restoring the ability to impose higher prudential requirements on or restrict activities of national bank and thrift subsidiaries of financial holding companies, authority stripped by the Gramm-Leach-Bliley Act in 1999. "That authority is consistent and necessary for putting the Fed more in charge of risk regulation," says Robert Litan, another Brookings fellow. "They have to give the Fed all the power it needs to carry out its new responsibilities."

Another proposal more controversial in theory than in practice would be the elimination of the housing-focused thrift charter and the regulator of thrifts. The move is derided by the ABA as one that "needlessly rips apart" the Office of Thrift Supervision and eliminates charter choice.

"Abolishing OTS is no real surprise," Bryan Cave's Wheeler says. Following the collapse of Washington Mutual and IndyMac last year and the takeover of Countrywide, there are no major thrift companies to fight for the agency's survival, he says.

Summers says the charter must be eliminated to end a practice of "regulatory arbitrage," which allows institutions to shop for a charter that permits them to pit regulators against each other in search for the most lenient oversight.

OTS is widely seen as having expanded far beyond its original mission and beyond its capabilities, Wheeler says. "OTS has historically been the regulator of local savings and loans. But some grew into global financial centers and probably out of the reach of OTS to properly regulate."

Given that bankers have persuaded Treasury not to pursue its larger goal of consolidating all four federal banking regulators into a single supervisor, eliminating the politically vulnerable OTS is an easy way to accomplish some level of regulatory streamlining, Orrick's Katz adds. "Because OTS has lost its biggest constituents, it doesn't have a base any longer to fight the fight. I don't know who is going to pound the table on its behalf."

Similarly, the Obama administration's refusal to merge the Securities and Exchange Commission with the Commodity Futures Trading Commission is another example of the up-front concessions that brighten legislative chances for the entire package. Instead, the administration has suggested that the SEC and CFTC jointly oversee financial derivatives.

It is a timid approach that worries many observers. Cynthia Krus, a partner and co-head of the corporate practice group at Sutherland Asbill & Brennan LLP in Washington, says not including a merger of the agencies in the plan "gives pause."

Adds Krus, "If you're going to promote sweeping changes and let something like this slide, it then becomes questionable what it is you're willing to stand up for."

But a jurisdictional battle between the agencies and the separate congressional committees that oversee them is more of a threat to the whole package than disappointment over tepid regulatory streamlining, says Fiona Philip, a partner with Howrey LLP and former enforcement counsel to the chairman of the SEC. Combining the two agencies would have been difficult at best, she says. "The political reality is the administration doesn't want to deal with a turf war" between the agencies or agriculture and financial services committees.

Another sought-after authority, enabling the government to seize and wind-down failing nonbank financial firms without forcing them into bankruptcy, is controversial because it would hand that power to the Federal Deposit Insurance Corp., whose chairwoman, Sheila Bair, has rocky relations with other regulators. Bankers also don't like the idea of giving the FDIC a role in dealing with nonbanks on the grounds that it will sully the image of safety and soundness that banks enjoy because of FDIC deposit insurance.

But Summers argued the FDIC is a natural choice because of its experience resolving failed banks. He said concerns about FDIC expanding its power are overblown because a majority of the Fed governors would have to approve any takeover of a nonbank financial firm, and with the concurrence of the Treasury Department. "The FDIC should play a central role, just as it does now," Summers said. "We are building on the current FDIC responsibility for manning the resolution process."

Controversy over Obama's plan will be dampened because it essentially implements separate suggestions offered in January by the Government Accountability Office and by the Group of 30, an organization of private sector experts and academics. Former Fed Chairman Paul Volcker chaired the committee that wrote the G-30's report on financial restructuring.

"A number of approaches that the steering committee recommended are in the president's plan," says Mark Walker, managing partner of Cleary Gottlieb Steen & Hamilton LLP, who served as an adviser to the G30 committee that prepared the report.

Also certain to make some waves is the recommendation that accounting standard-setters make more progress in agreeing on a single set of accounting standards by the end of the year and iron out differences over fair value accounting. Accounting for so-called toxic assets with their ambiguous values and firms' exposure to them are at the heart of the financial crisis. They still plague balance sheets, and will continue to do so until a solution is reached. Banks have bristled at reforming accounting standards, saying that each balance sheet is different, as are lending standards, asset mix and regional exposure.

But again, the administration's plan didn't come out of the blue. It builds on recommendations issued at a recent summit of the Group of 20 world leaders. It recommends that the accounting standard-setters, the Financial Accounting Standards Board and the International Accounting Standards Board, along with the SEC, "clarify and make consistent the application of fair value accounting standards, including the impairment of financial instruments, by the end of 2009."

There will also be a battle over the president's plan to establish a consumer protection agency for financial products. The entire notion is opposed by bankers but the administration is insistent that banking agencies failed to protect borrowers from inappropriate products such as subprime loans. Geithner stressed that the agency will have authority over instruments in which consumers are taking credit exposure and would not overmeddle in investment and savings products.

Senate Banking Committee Christopher Dodd, D-Conn., insisted last week that protecting consumers against dangerous financial products is "a first priority." The senator also lashed out at financial firms opposing a new agency, saying they do it at their own risk.

"The very people who created the damn mess are the ones" now saying they will oppose sensible changes, Dodd declared at a June 18 hearing on the overhaul plan.

But a lot of details need to be worked out before the industry's concerns are allayed. Most importantly will be the exposure to additional regulation by state officials, says Baily. The current proposal stresses that the consumer protection agency's rules are meant to be minimum standards and state regulators are free to impose stricter ones. "There are no limits on the states," he says, warning that financial institutions that are in compliance with federal law could nevertheless be vulnerable to a "crusading attorney general."

The fight over consumer protection is brewing to the biggest one in the reform plan. But unlike many of Obama's other reform proposals, details of the consumer protection agency were never floated in a trial balloon. Last week's announcement was the trial balloon. If the administration is as willing to bend on consumer protection as it has been on other controversial measures, the new agency -- and the overall reform itself -- might become reality.

Post a comment

Name:

Email Address:

URL:

Remember personal info?

Comments: (you may use HTML tags for style)

Please only click "Post" once. It may take a few moments to process.