A Bipartisan Deal on Banking Reform?

In the days since Senate Banking Chairman Chris Dodd (D-CT) laid out his bill overhauling the U.S. financial regulatory structure, this much has become clear: In trying to make everyone happy, he’s managed to make no one completely happy. That sounds like the makings of a real compromise, and it could turn out that way, with the emphasis on could.

Dodd’s 1,336 page financial reform proposal is merely the latest in a series of “opening salvos” in what will turn out to be a contentious but potentially fruitful battle over how to overhaul the way lenders, insurers and key market players are regulated. His release of the bill after months of closeted discussions with key Republicans on his committee now pushes the process into daylight. Dodd, who isn’t facing reelection, has raised the stakes for both Democrats and Republicans who will have to answer to voters still furious at Wall Street, who they blame for the financial crisis. Lawmakers in both parties are so eager to align themselves with these angry voters that they will at least have to appear to be working toward a final compromise. That could be enough political motivation to help them overcome partisan differences.

Dodd has already backed down from the more sweeping provisions he offered last November. But he still didn’t give his Senate Republican negotiating partners, Richard Shelby (AL) and Bob Corker (TN), everything they wanted, and as a result, they wouldn’t sign on to his draft. He won’t need Republican support to push the bill through his committee by April. But he will need at least one GOP vote – and realistically a lot more -- when the bill gets to the floor of the Senate, which is when the real back and forth will begin. To get that bipartisan backing, Dodd will have to drop his most contentious proposals, such as the one aimed at limiting the financial bets banks make amongst themselves. In doing so Dodd risks alienating Democrats, some of whom already complain the proposals are too watered down.

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Dodd’s compromise contains plenty of pitfalls. For example, he proposes giving existing regulatory bodies additional powers even though these same agencies were criticized for bungling their mandates leading up to this crisis. The Securities and Exchange Commission, which failed to spot Bernie Madoff’s Ponzi scheme and is still being rebuked for being too easy on wrongdoers, would get new power over derivatives, investor protection rules, large hedge funds and credit rating agencies. The Federal Reserve, which rarely exercised its existing consumer protection powers, would house a new consumer agency. Plus the central bank would get new powers to wind down big financial firms in addition to its existing mandate to set monetary policy.

These issues will make the bill a political and policy minefield, more so because it deals with complex and very technical issues that few lawmakers, and far fewer voters, really understand. And once the Senate passes a bill -- if it does -- it must be reconciled with a House version that is far closer to the original democratic proposal championed by President Obama.

If a bill does pass, Robert Litan, vice president at the Kauffman Foundation, warns against either side claiming too much credit. “I don’t think politicians should raise people’s hopes, ” he says, adding that lawmakers shouldn’t boast that any reforms will prevent another financial crisis. Incompetent regulators and overzealous traders aren’t going anywhere. As he rightly points out, “You can’t legislate bubbles out of existence and you can’t legislate incompetence out of the system.”