The first major strengthening of financial regulation since the 1930s appears far more likely now that the Senate finally passed its bill last week. As lobbyists maneuver to weaken the final bill, House and Senate negotiators must remain focused on making the financial markets more transparent and less prone to the self-dealing and risk-taking that contributed to the economic meltdown. • While far from perfect, the Senate and House bills generally accomplish the same goals: They force risky derivatives trading out of the shadows, allow for the dismantling of large troubled financial institutions, toughen capital requirements, strengthen consumer protection and reform the credit ratings agencies. But there are differences between the approaches, with strengths and weaknesses in each. The challenge will be to tune out the lobbyists and the Chamber of Commerce while focusing on keeping the toughest provisions of each bill intact. • The bills still don't go far enough in a number of areas, including separating commercial and investment banking activity and holding broker-dealers accountable for the advice they give clients. The House bill creates a duty of care for retail clients of broker-dealers only, not big investors like pension funds. The Senate would study the issue. • There is still much work to be done by congressional negotiators, but financial reform is finally headed in the right direction.
Derivatives: The Senate bill is tougher than the House's in regulating those opaque, complex instruments blamed for exacerbating the financial crisis. Both require derivatives to be cleared and traded on exchanges, bringing them into the open and allowing for regulation. A Senate amendment sponsored by Sen. Blanche Lincoln, D-Ark., forces banks to spin off their derivative trading desks into subsidiaries. The idea is to protect taxpayer-guaranteed deposits from the risk of derivatives. The House doesn't include this provision, and banks will fight it because derivatives are hugely profitable. The Senate provision should prevail.
Resolution Authority: Both bills enable federal regulators to seize foundering financial giants and liquidate them. The House creates a $150 billion fund raised from large financial institutions, while the Senate has taxpayers fronting the cost, to be recouped later from the financial sector. The House version makes more sense.
Consumer Protection: The House creates a stand-alone Consumer Financial Protection Agency with the power to police abusive lending practices in financial services. The Senate creates a weaker sister by establishing a similar bureau for consumer financial protection within the Federal Reserve. The House approach is more consumer-friendly, but it exempts auto dealers from oversight. Most car loans are obtained through dealerships, and consumers can easily be exploited. There should be no exemption.
Credit Rating Agencies: Both bills require more transparency in the agencies' rating methods and increase oversight by the Securities and Exchange Commission. Both increase the liability that agencies face for their judgments. But only the Senate directly addresses the conflict of interest problem, where financial institutions shop for ratings of their products. A new regulatory body — not the banks — would pick an agency to do the initial rating of each new financial instrument. This sweeps away the cozy relationships between banks and agencies that rate the riskiness of their securities.
Volcker Rule: When a bank that takes federally insured deposits engages in speculative trading for its own benefit, it is gambling with taxpayer dollars. Unlike the House bill, the Senate bill enables regulators to write rules barring banks from proprietary trading. That would reduce the risk for those financial institutions and reduce conflicts of interest in firms that are also trading for clients.