End Game: Senate "Compromise" is Gutting Financial Reform

Last Updated May 19, 2010 3:33 PM EDT

Sen. Chris Dodd may not, King Solomon-like, have proposed cutting his baby -- the financial-reform bill now before the Senate -- in half, but he is kicking it down the road. Both solutions are likely to be fatal.

The Connecticut Democrat yesterday sought to postpone for two years any consideration of a plan to force banks to stop trading derivatives. Dodd also wanted to assign the new council of financial regulators called for under the financial reform bill to "study" the idea, which is backed by Sen. Blanche Lincoln, D-Ark. But Dodd had to withdraw his amendment on Tuesday amid angry denunciations by liberal Democrats. Wall Street firms also opposed the Dodd proposal, hoping instead to kill the derivatives ban outright.

It's long been apparent that this critical element of financial reform is a long-shot. For now, it lives to fight another day. Say University of Massachusetts economists Jane D'Arista and Gerald Epstein in a letter opposing Dodd's plan:

Burying [the Lincoln amendment] would be a significant blow to trying to rein in the dangerous practice of massive banks undertaking socially destructive activities with taxpayer guaranteed funds.
Along with the fight over derivatives, the financial industry has succeeded in diluting other parts of the bill. With the Senate set to vote on the measure later this week, here's a brief rundown of where things stand on six key issues still under debate:

Consumer Financial Protection Agency. The proposed regulatory body will be housed within the Fed, which has a dreadful record of shielding people from deceptive and unfair financial products. CFPA rules will also be subject to veto by other financial regulators, greatly curtailing the new agency's ability to police the banking industry.

Volcker Rule. Republicans continue to block a vote on the so-called Merkley-Levin amendment, which would bar large banks from proprietary trading. As Mike Konczal recently explained, such restrictions would help deter big banks from exploiting their federal guarantees in order to speculate in risky markets -- that is, preventing them from gambling on the taxpayer's dime. Also up in the air are possible exemptions for certain financial firms, such as merchant banks.

Capital standards. Bank industry lobbyists, along with Treasury and Fed officials, are working to scuttle an amendment authored by Sen. Susan Collins, R-Maine, that would require big banks to meet higher capital requirements. Voicing support for the measure, FDIC Chairman Sheila Bair has called it "a critical element to ensure that U.S. financial institutions hold sufficient capital to absorb losses during future periods of financial stress."

Preemption. In some cases, U.S. states would have expanded authority to regulate national banks. That's an improvement on the current legal standard, under which states have no right to enforce federal protections. But the bill also makes it easier for banking regulators to block state officials from pursuing some consumer protection cases -- even those not covered by federal law.

Glass-Steagall. A plan by Sens. Maria Cantwell and John McCain to revive the Glass-Steagall Act, a Depression-era law that separated commercial and investment banking, appears to be on the chopping block. White House, Treasury and other government officials oppose it, arguing that it would harm big U.S. banks' competitiveness.

Synthetic derivatives. As of Tuesday, Sen. Byron Dorgan was persisting in his commendable fight to ban "naked" credit default swaps, a purely speculative type of derivative that lets investors buy insurance on securities without actually owning them. The House has already passed such a measure as part of its reform package, but it remains unclear if Dorgan's provision has enough support in the Senate to survive.

The upshot? The Senate will pass financial reform. The next step will be to reconcile the legislation with the House bill. But the goal here isn't to enact law -- it's to redress some of the problems that caused the financial crisis. On that score, as I've argued previously, the measure falls short. It's somewhere between a band-aid and a tourniquet, and a long way from any sort of inoculation against future crises. Konczal writes:

Between the last minute changes, the way the bill has morphed into an endless stream of studies to be ignored at a later date, the dropping of any of the strong progressive resolution mechanisms in the House and the blocking of votes and discussion on Dorgan, Merkley-Levin and Cantwell's amendments, this has really been a massacre of what was originally a fairly decent bill.
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    Alain Sherter covers business and economic affairs for CBSNews.com.