Senate Financial Regulations Threaten U.S. Economy

The Senate crept closer to passing the Democrats’ sweeping overhaul of the nation’s financial regulations that critics on both sides of the debate warn will hamstring America’s financial system and weaken the economy.

Under pressure from Republicans who have dramatically slowed down the legislation with a fusillade of 175 amendments, Democratic leaders were dealt a major blow this week when the Senate adopted a GOP-backed amendment that killed the $50 billion government bailout provision that had come to define the bill.

The lopsided 93-5 vote (Only four Republicans—Senators Coburn, Cornyn, DeMint and Hatch—one Democrat—Sen. Dorgan voted to retain it) gave the GOP’s rear-guard attempts to rewrite the bill a temporary political boost. 

But the rest of the 1,500-page bill remains a major assault on the financial industry that will give the federal government vast new powers to poke its nose into virtually every nook and cranny of businesses, large and small, from Wall Street to Main Street.

“Remember, this affects all of our economy—everything,” Alabama Sen.
Richard Shelby, the ranking Republican on the Banking Committee, warned his colleagues last week, as Senate Democratic Leader Harry Reid (Nev.) urged faster action.

But another battle was brewing over the bill’s most controversial provision that would force the nation’s biggest banking institutions to end their derivatives businesses that have long been a huge money-making segment of the financial industry’s risk-lowering strategy here and abroad. 

In what is shaping up as an unholy alliance of Republicans and some administration officials—including presidential adviser Paul Volcker, the former Federal Reserve chairman—the bill’s Democratic sponsors now find themselves playing defense on an issue that they blame for much of the financial system’s collapse in 2008.

But in a surprising public letter to senators on both sides of the aisle last week, Volcker defended derivatives—a financial insurance practice to lower risks and lock in fluctuating prices of commodities such as oil—as an essential element of good business practices.

The nation’s banking industry provides derivatives to its clients “in the usual course of a banking relationship” and this widely accepted practice should not be banned, Volcker told the Senate.

Volcker is not alone among Obama’s top economic advisers in opposing the ban. Treasury Secretary Timothy Geithner also wanted to drop the provision sponsored by Senate Agriculture Committee Chairwoman Blanche Lincoln (D.-Ark.).

It is also opposed by senators on both sides of the aisle who have been inundated by complaints about Lincoln’s proposal from financial industry groups back home.

The provision would prohibit the Federal Reserve and Federal Deposit Insurance Corporation from extending assistance to banks that engage in major derivatives transactions.

“This is an ill-thought-out idea. Not only would it push a lot of business offshore, it would contract credit on Main Street significantly,” said New Hampshire Sen. Judd Gregg, who with two Republican colleagues, Bob Corker of Tennessee and Saxby Chambliss of Georgia, is offering an amendment to delete the provision. 

While complicated and little understood by most Americans, derivatives are “as ancient as civilization,” says economist Peter Morici of the University of Maryland’s School of Business.

Even “Greek farmers insured crops with investors prepared to speculate on the weather, just as life insurers hedge mortgage-backed securities by purchasing credit default swaps,” Morici writes in a recent defense of derivatives.

“When written against real assets—farmers’ crops or homes—derivatives spread risk, lower capital costs and foster growth,” he says. “Pushing virtually all transactions through standardized contracts on public platforms will work poorly, concentrate risks and lower economic growth.”

“Derivatives are simple contracts among consenting adults, and we know how laws to enforce private morality work—they don’t!” he said.

Thus far, however, Democrats have been able to protect the guts of the bill that the administration and Banking Committee Chairman Chris Dodd (D.-Conn.) have put together—including its core provision to create a new government consumer-protection bureau with broad powers over the financial services industry. Last week, they beat back a major Republican attempt to narrow its reach and authority.

While the bill would significantly expand the government’s power over the financial industry and its role in the nation’s economy, it has not drawn the kind political outrage and grassroots opposition that the national healthcare legislation drew, and that has made the GOP’s legislative fight more difficult.

Indeed, the government’s civil-fraud suit against the Wall Street firm of Goldman Sachs, followed by the Justice Departments criminal investigation, has strengthened the Democrats’ political hand in the current legislative battle over the regulatory bill.

That has undermined, or at least muted, the GOP leadership’s offensive against the bill. While their goal in the healthcare debate was to kill Obamacare, their legislative goal in this debate is to think “of ways to make this bill better,” Corker told The Washington Post.

With polls showing that a majority of Americans have soured on Wall Street and think it is in need of tougher oversight, the Democrats have the upper hand in this regulatory fight—at least for now.

"One of the dangers of the Senate financial reform bill is that it includes so many provisions that could damage the financial services sector that just fixing one or two would not even come close to making it an acceptable bill," Heritage Foundation economic analyst David John told HUMAN EVENTS.

"We started a list of serious problems with it, and finally stopped after reaching 14. Merely deleting the $50 billion fund and putting in a few strong statements against future bailouts does not come close as long as the derivatives section and the new consumer agency is still in the bill, and even after dropping those sections there would still be major problems with what is left," he said.