Why the Financial Reform Bill is Better Than Nothing (But Not by Much)

It's time to make the sausages. After months of partisan wrangling, debate starts today in the U.S. Senate over legislation that could significantly reshape the financial services industry. Or not.

Sorry for the qualifier. But lots is still on the table, including provisions that would create a Consumer Financial Protection Agency, regulate derivatives and rein in proprietary trading. In the days and weeks ahead, lawmakers will cut deals, lobbyists will wheedle, promises will be made and broken. In all likelihood, we'll end up with a law. But what kind?

As usual, it's a matter of perspective. If the benchmark of success is bringing huge financial firms under control, as President Obama and Congress keep vowing, then expect to be disappointed. The new law may make large banks marginally less profitable, but it won't reduce, and in some ways may increase, their financial and political primacy.

If any bill is passed, both parties will uncork the champagne and declare an end to the era of "too big to fail." Don't be fooled. Six players -- Bank of America (BAC), Citigroup (C), Goldman Sachs (GS), JPMorgan Chase (JPM), Morgan Stanley (MS) and Wells Fargo (WFC) -- today have total assets equaling 60 percent of America's GDP, triple the industry concentration level in 1995. TBTF is alive and well.

Failure to confront that problem is a result of our political class engaging in the usual triangulation. Writes Robert Johnson, former chief economist of the Senate Banking Committee and now director of New York think-tank the Roosevelt Institute:

"Elected officials are trying to reconcile their need to appease donors in the financial sector with recognition of the legitimate demands of an enraged public. But they cannot do both."

A case in point is the fight over the CFPA. Sen. Richard Shelby, R-Ala., is pressing to subordinate the proposed agency to the Federal Reserve, U.S. Treasury, OCC and other financial regulators. That's no minor inconvenience. These agencies are, to put it mildly, on good terms with Big Finance. To give them veto power over the CFPA would greatly undermine its ability to write and enforce rules shielding consumers from abusive financial practices.

By contrast, if the yardstick is making modest improvements to the financial system, then you'll be pleased. While banks are unlikely to be banned from selling derivatives, as Sen. Blanche Lincoln, D-Ark., has proposed, trading in these instruments will probably move to a clearinghouse. That should bring some, but by no means all, of the shadow banking system into the light.

Creating a so-called Financial Stability Oversight Council to monitor systemic risk also should reduce the chances of another major non-banking company, such as AIG (AIG), suddenly turning to ash. And if we're going to allow financial giants to continue roaming the land, that's critical.

As I said, of course, the horsetrading in Congress is intensifying. Sen. Chris Dodd, D.-Conn., who's leading the reform debate, has yet to incorporate any changes into the Senate bill. That probably won't happen until next week. Until then, hold the mustard.

Hot dog image from Flickr