Financial regulation reform faces stiff opposition

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 sweeping 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 White House and Democratic allies prepared for a crucial vote within days to bring the entire reform package up for debate in the full Senate. The House passed similar legislation in December.

Obama is trying to ratchet up public support for reining in Wall Street as financial firms recover much more quickly from the deep recession than rest of the country. But reflecting optimism on Capitol Hill about a bipartisan deal, the president toned down his anti-Wall Street rhetoric Wednesday.

“We have to have a thriving financial sector,” Obama said on a CNBC interview. “But we also have to have basic rules of the road in place to make sure investors, consumers, shareholders, the economy as a whole are protected against excess.”

Still, Wall Street is battling aggressively against the legislation. Here’s a look at the 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 murky 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 Wall Street’s battered firms was American International Group Inc., 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% 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.

But major Wall Street firms and businesses said the proposed restrictions, which contain only narrow exemptions, are too tough and would simply increase the price of derivatives, with the costs passed to consumers. The rules also could drive derivatives business to countries with less regulation.

Major banks, such as Goldman Sachs Inc., JPMorgan Chase & Co. and Bank of America Corp., 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.

Those firms and others involved in the derivatives market are pushing to ease the new restrictions, as are many Republicans. But Obama said last week he would veto the overhaul if it did not include tough regulation of derivatives.

The subprime mortgage meltdown stemmed in large part from loan brokers and banks steering people into risky mortgages on the belief that housing prices would continue to rise. Those mortgages — including subprime, interest-only and adjustable-rate loans — took advantage of consumers who didn’t understand the products or the risks they were taking.

Banking regulators failed to curb the practices until it was too late.

The Federal Reserve, which writes consumer protection rules for financial products, was given the authority to deal with so-called predatory lending by Congress in 1994. But it took 14 years for the central bank to enact its such rules — after the crash of the housing market.

A new consumer financial protection agency

A centerpiece of Obama’s regulatory overhaul proposal, was a new 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, most notably the U.S. Chamber of Commerce.

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 could 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. The White House prefers a stand-alone agency, but said Dodd’s proposal was acceptable because the bureau would be independent.

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.

Without such power to deal with nonbanking firms, the Federal and the Treasury had to concoct a series of loans to bail out AIG in 2008 amid fears that its bankruptcy could cripple the financial system.

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 sharp 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.

“If you pre-fund it there’s a greater likelihood it will be used,” said David Hirschmann, a U.S. Chamber executive. “At least if it’s post-funded people will stop to ask what do we need here and how are we going to use it.”

Dodd and the administration have said they are prepared to adopt a postpaid fund.

jim.puzzanghera@latimes.com