Senate's banking reforms miss the mark on containing risk © Charles Smith/Corbis

Extra4/16/2010 11:40 AM ET

The fight we need over Wall Street reform

Don't let partisan posturing over banking regulation obscure the fact that the proposed reform won't prevent the risk-taking that fueled our recent crisis.

By Paul M. Barrett, BusinessWeek

Senate Democratic leaders on Thursday rejected Republicans' objections to a financial reform bill and said they would bring the legislation to a floor vote next week.

The political media will track, in excruciating detail, the trapeze act of Banking Committee Chairman Chris Dodd (D-Conn.) as he reaches for the elusive 60th vote needed to push his bill past a GOP filibuster. The clowns on both sides will emit their reliably windy rhetoric: Republicans claiming that the legislation will invite more outrageous bailouts, Democrats that this bureaucratic reshuffle will fend off the next financial cataclysm.

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The whole depressing circus will be beside the point. There's one clear issue at the heart of regulatory reform -- one obvious measure that lets you know whether the bill is worth the price of admission -- and the Dodd legislation ducks it. What's missing are strong rules forcing banks to raise capital and liquidity levels. Such restrictions would be a real buffer against the sort of risk-taking that fueled our recent crisis.

Instead of building this buffer, the Senate will argue about issues that amount to little more than elaborate distractions. First, the Dodd bill would create a consumer protection agency to prevent home loan and credit card abuses. Republicans, echoing JPMorgan Chase (JPM, news, msgs) CEO Jamie Dimon and his cohorts, attack the plan as hostile to capitalism. Dodd has compromised by sequestering the watchdog within the bank-friendly Federal Reserve. Look for him to offer more cosmetic changes to tempt GOP crossover votes.

Additional consumer protection makes good sense. But fabricating a brand-new agency smacks of symbolism. Existing regulatory bodies already have the powers that would be invested in any new agency.

With or without a reform bill, if the White House put real cops on the banking beat, we would see real enforcement. If we get the sort of do-nothing crews we've had since Ronald Reagan, rearranging the seating charts won't make much of a difference.

Capital and liquidity requirements

The other fake debate will focus on proposals to enhance Washington's authority to put to rest troubled financial giants -- a less traumatic "do not resuscitate" procedure for the next Lehman Brothers.

The Democrats want to give regulators more tools to liquidate endangered Wall Street Goliaths without the panic sparked by Lehman's abrupt Chapter 11. Republicans, warning that their mollycoddling foes are encouraging taxpayer giveaways, argue that ordinary bankruptcy court is sufficient. Again, the argument seems tangential.

In the midst of a future meltdown -- God help us -- politicians aren't going to risk either the liquidation of interconnected financial institutions or another Chapter 11 train wreck. As long as we allow the leviathans to get too big to fail, they will be, well, too big to fail. We will rescue them to prevent worldwide depression. That, predicts Douglas J. Elliott, a former investment banker who is now at the Brookings Institution, will likely lead to "the same type of stumbles and traumas as we just went through."

Which brings us to the issue that deserves attention but will be largely absent from the Capitol Hill theatrics: capital and liquidity requirements.

Capital is the investment in a financial institution that doesn't have to be paid back to anyone. When a bank's assets -- say, exotic real-estate-backed securities -- fall suddenly in value, its capital provides a bulwark against disaster. In the last debacle, too many Wall Street institutions lacked sufficient capital. They were too highly leveraged. Since 2007, U.S. banks have boosted cash reserves and raised $519 billion of capital at the urging of regulators, Bloomberg News reported last month. As memories of the crisis fade, however, those stockpiles will diminish -- unless someone sets tough rules.

As a chastened Alan Greenspan told the Financial Crisis Inquiry Commission on April 7: "The primary imperatives going forward have to be increased risk-based capital and liquidity requirements on banks and significant increases in collateral requirements for globally traded financial products."

Continued: Without fear or favor

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