U.S. reforms will nick, not nuke, big banks

May 20, 2010

A sigh of relief is due on Wall Street. The procedural finale for the Senate’s debate on financial reform came just in time for banks. The bill got tougher as the talk dragged on. But it could have been worse. While banks’ future activities and profitability may get pinched, their core business model appears intact.

Had President Barack Obama prioritized bank reform over healthcare at the height of the crisis, the biggest players might have been broken up, hard caps placed on balance sheets, and banking and investing operations separated. More recently, the Securities and Exchange Commission’s lawsuit against Goldman Sachs  in April helped re-energize advocates for such changes.

It’s safe to say the most radical ideas have fallen by the wayside. A “systemic risk council” of federal regulators will recommend new capital and leverage rules to the Federal Reserve, which will be the most influential bank regulator. The Federal Deposit Insurance Corp will have the power to wind down any failing large, systemically interconnected institution.

In addition, large, complex financial firms will have to submit plans for their rapid and orderly shutdown should they go under. And for the first time the derivatives that are currently traded privately will mostly be forced to go through clearing houses and in some cases trade on exchanges. Bank lobbyists have defended their corner: it’s not the regulatory reign of terror their clients’ most vociferous critics wanted. But it’s hardly a “light touch” regime, either, and it does involve real changes.

There’s still the chance that the bill’s limitations on banks’ derivatives activities could be further tightened. And the Senate’s final effort will then need to be blended with the House version, a process during which restrictions on derivatives and possibly proprietary trading — the so-called Volcker rule — will really be hammered out. So the book isn’t yet fully written.

Meanwhile, Wall Street’s continued unpopularity will no doubt spawn further attempts to tax, regulate and restrict the sector. And that’s ignoring the inevitable empty rhetorical attacks in this election year. For now, though — perhaps surprisingly — pragmatic policy has trumped punitive politics.

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