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A Last Bid to Protect Wall Street

The following column is by Pat Garofalo, an Economics Researcher at the Center for American Progress and a Blogger at the Center for American Progress Action Fund.

Conservative lawmakers and Wall Street lobbyists are waging a last-ditch effort to convince a few wavering senators to vote against the Dodd-Frank Wall Street Reform and Consumer Protection Act, the financial regulatory reform bill, when it comes up for a vote later this week. The legislation, which emerged from a congressional conference committee last month, was already approved by the House of Representatives. This means that there is just one more vote left before the bill reaches President Barack Obama’s desk.

The Dodd-Frank bill is not perfect—no legislation ever is in our democratic give and take—but it is an important step toward building a stable, fair financial system that works for consumers and not solely in the interest of the country’s biggest banks. It addresses a critical gap in the regulatory framework by creating a new Consumer Financial Protection Bureau, giving government regulators the tools they need to wind down failed firms without resorting to the ad-hoc overnight bailouts of 2008, and putting rules in place that will shed light on the opaque $600 trillion derivatives market that was at the heart of the economic meltdown. It will also rein in the riskiest trading practices of too-big-to-fail banks, keeping federally insured dollars out of the Wall Street casino.

In their first attempt to kill the legislation, conservatives coalesced around their favorite faux populist talking point, arguing that the bill will result in permanent bailouts for big banks. "This bill sets up a permanent bailout regime that puts the government in charge of picking winners and losers," said Rep. Randy Neugebauer (R-TX), one of many such comments in the conservative media echo chamber. It’s easy to see why conservatives would want to raise the specter of more and bigger bailouts to gin up opposition to the bill, but their rhetoric doesn’t match the reality.

In fact, the bill creates a clear resolution authority for unwinding big financial institutions without calling on taxpayers to bear the burden. Dodd-Frank lays out a process for identifying whether a failing financial institution is too systemically entangled for traditional bankruptcy and, if so, puts it into an FDIC-style receivership, after receiving approval from a panel of bankruptcy judges. It is the opposite of the shotgun approach to which the government was limited in 2008.

Having failed to scuttle the legislation using this false allegation, conservatives and their Wall Street allies turned to kindred executives in corporate America, asking them to make the case that the derivatives portion of the bill will drive up costs for companies that want to use these complex instruments to hedge against risk. Case in point: Tom Deas, treasurer of the chemicals manufacturer FMC Corp., claims that companies like his “will need to post hundreds of millions of dollars in additional margin. Nobody ever did a cost-benefit study of the effect of this bill on end users.” And the International Swaps and Derivatives Association, which includes Wall Street derivatives dealers as well as corporate end-users, estimates that derivatives reform will require companies to post an extra $1 trillion in collateral against possible derivatives losses.

Treasury Secretary Tim Geithner has replied that there is “no basis for those estimates or those concerns in my view,” adding that the bill allows companies to continue hedge risk “in ways that meet their specific needs, but to make sure the system as a whole is safer, that stuff happens in the light of day with transparency and disclosure.” Indeed, the bill already includes exemptions from the exchange and clearing requirements for end-users that are legitimately hedging risk, particularly corporate America.

Plus, as Commodity Futures Trading Commission Chairman Gary Gensler explained in an address before the U.S. Chamber of Commerce, transparency in the derivatives market should lower costs across the board:

You have concerns that the margin—or collateral—required to clear derivatives could be costly. Derivatives dealers, however, already charge counterparties for credit extensions when they do not clear their transactions. How can you know that these costs charged by the dealers—embedded and opaque—are less than the margin associated with clearinghouses? At least margin requirements imposed by clearinghouses are transparent to all market participants and subject to review by the appropriate regulator.

To be sure, regulators will have to ensure that appropriate hedging doesn’t get caught up by the new regulations. But it is in the interest of these companies to have a functional and fair market for derivatives. And they will have ample opportunity to weigh in on any legitimate concerns about their hedging needs when the regulators seek comment on the rules they design based on the Dodd-Frank legislative language.

So let’s step back a moment. With the chorus of conservatives warning of cataclysm should Dodd-Frank become law, it is worth remembering how the nation found itself in such desperate straits in 2008. Not only did federal regulators under the Bush administration actively remove regulations that kept Wall Street in check, but they also refused to enforce the rules that remained on the books, particularly when it came to consumer protection.

Remember, just a few months before the economic meltdown, the Bush administration released its sweeping plan for deregulating the financial industry. A deregulatory philosophy espoused by, among others, former Federal Reserve Chairman Alan Greenspan, held that the market would automatically correct for any imbalances, including a proliferation of predatory lending.

Warnings from officials such Sheila Bair (now chairman of the Federal Deposit Insurance Corp.) and housing advocates such as the Greenlining Institute did nothing to shake this vision; and in the meantime, Wall Street ran wild, securitizing subprime loans, selling them around the world, and then placing bets that the whole system would fall apart.

Greenspan, at least, has come around and said that his views at the time were misguided. “Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief,” he said in October 2008. If only today’s conservative lawmakers had the same belief in the strength of hindsight. Instead, they conjure up imagined dangers to score political points and curry favor with important Wall Street political donors—never mind the very real dangers to our financial markets and businesses large and small if comprehensive financial reform were scuttled in favor of the status quo that led us into the Great Recession in the first place.

Pat Garofalo is an Economics Researcher at the Center for American Progress and a Blogger at the Center for American Progress Action Fund.

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