As President Obama heads to New York City on Thursday to press for a major overhaul of financial rules, he faces stiff opposition by Wall Street to the toughest proposed regulatory crackdown since the Great Depression.
A Senate committee on Wednesday approved the final piece of the legislation: strict new oversight of the murky and unregulated market for complex financial derivatives. It is one of three significant provisions that rile Wall Street the most.
Also drawing fire from large financial firms and business groups is a proposed agency to protect consumers in the financial marketplace and a $50 billion fund, paid for in advance by the industry, to help cover the government’s costs should it need to seize and dismantle a large financial firm because its impending failure would threaten the economy.
The Senate Agriculture Committee approved its piece of the overhaul as the administration and Democratic allies prepared for a crucial vote within days to bring the entire overhaul package up for debate in the full Senate. The House passed similar legislation in December.
Wall Street is battling the legislation. Here are three key areas of dispute:
Tough derivatives oversight
Derivatives get their name because they derive their value from something else, such as interest rates, currency-exchange rates, mortgages or the price of corn or oil.
Credit-default swaps and other derivatives are complex business contracts that typically serve as insurance against future market conditions. An airline concerned that jet-fuel prices would rise or a bank worried about an increase in interest rates could buy derivatives to protect against those events.
But derivatives also can be used to bet on the performance of assets or markets, and that’s where the abuses took place that nearly crashed the world economy. Supporters of tough new regulations say those deals amounted to high-stakes gambling in a market that functioned like a huge unregulated financial casino.
Derivatives were an emerging business tool in 2000 when Congress enacted legislation that largely exempted them from federal oversight. As the housing market inflated, the use of derivatives boomed, from about $95 trillion in 2000 to $600 trillion last year.
When the housing bubble popped, the derivatives market tied to mortgages crashed with it. Among the battered firms was American International Group (AIG), which received a bailout because it could not cover billions of dollars’ worth of credit-default swaps it had written as insurance for investments tied to mortgages.
Regulators were largely unaware of the widespread exposure to the derivatives market by AIG and other firms. Although some derivatives are voluntarily traded on public exchanges, most are not, leaving prices and the volume of deals in the dark.
“We must bring transparency and accountability to these markets,” Senate Agriculture Committee Chairwoman Blanche Lincoln, D-Ark., said shortly before her panel voted 13-8 to approve new derivatives regulations. The Agriculture Committee has oversight because derivatives play a large role in farming.
The overhaul legislation would require about 90 percent of derivatives to be traded on regulated exchanges and be approved by central clearinghouses. Those processes would ensure there was enough money backing up the deals and provide details about the contracts and their prices that make it harder to defraud investors.
Major banks, such as Goldman Sachs, JPMorgan Chase and Bank of America, have huge derivatives businesses and would be big losers if the new regulations took effect. The Senate proposal would require banks to spin off their derivatives businesses to subsidiaries.
A new consumer financial-protection agency
A centerpiece of Obama’s regulatory overhaul proposal was a Consumer Financial Protection Agency. The agency would take the rule-writing authority from the Federal Reserve and the power to examine banks and other financial firms for compliance from the Fed and other banking regulatory agencies.
The proposal has drawn criticism from banks and businesses.
Opponents said the agency would have too much power and too little oversight. They said its rules could limit the availability of credit to consumers and businesses and endanger the fiscal health of institutions by crafting rules without input from banking regulators, who are charged with ensuring that banks don’t fail.
Lobbying from businesses and banks — along with opposition from existing regulators — led the House to scale back the agency’s powers.
Small community banks and credit unions, for example, would continue to have their consumer-compliance exams done by banking regulators instead of the new agency to avoid paying the costs for two sets of exams.
Stiff opposition from Republicans led Senate Banking Committee Chairman Christopher J. Dodd, D-Conn., to make more changes in his version of the legislation. Instead of a stand-alone agency, he would place it in the Fed, where it would still have an independent head and budget. Its powers otherwise would remain largely the same as originally envisioned.
That change isn’t enough for opponents, who said the agency still would wield too much authority.
A prepaid fund to dismantle large financial firms
The legislation also aims to prevent future bailouts by giving the government authority to seize and dismantle large firms that are on the brink of bankruptcy, should their failure threaten the economy.
The so-called resolution authority would resemble the power of the Federal Deposit Insurance Corp. to step in before a bank failure and shut it down in an orderly way or sell it to another financial institution.
New authority under the overhaul would allow an orderly shutdown of a large firm to avoid market chaos that could result from uncertainties about the bankruptcy process.
But the House, trying to avoid sticking taxpayers with the costs of any shutdowns, proposed that large financial firms pay a total of $150 billion into a reserve fund in advance so it would be ready in case it was needed.
The plan drew criticism from Wall Street, the financial industry and business groups. They argued that having that money in place would make it easier for the government to use it.
Dodd attempted to ease that criticism by reducing the fund to $50 billion, but opponents still oppose it. They prefer to have the government collect payments to cover the costs only after it starts to close a large firm.