If you don't learn from history, you're condemned to repeat it. That's why a nutshell review of the 2007-09 financial crisis is in order as Congress passes a massive Wall Street reform bill.
The crisis grew out of a ramp-up of federal support for mortgages to homebuyers who were either unworthy of big mortgage debt or unaware of their loans' details. These shaky purchases helped create a housing bubble, while the iffy mortgages were blindly snatched up by Wall Street investors. The risks were magnified by shoddy practices at credit-rating companies, the derivatives industry and banks.
When the bubble burst, Washington didn't have enough tools to prevent the fallout.
Now, more than a year later, a 2,319-page bill known as the Dodd-Frank Wall Street Reform and Consumer Protection Act aims to prevent a repeat of this worst economic disaster since the Depression. And, just in case the remedies don't work, the legislation passed today makes it easier for government to clean up future financial messes.
The bill passed the Senate 60-39, giving President Barack Obama a major domestic-policy victory. Obama is expected to sign the legislation into law next week, but the work on rewriting the nation's financial rules will continue. The legislation faces a long highway of implementation, with potential off-ramps for its most difficult provisions.
Regulators will shape the law
Congress, for instance, leaves it up to regulators to make dozens of the toughest decisions, such as compensation for bank officials, the types of proprietary investments that banks can pursue, the determination of when a company is too big to fail and the amount of money that big financial companies must keep in reserve.
Granting such wide discretion to regulators may give them flexibility in responding to a crisis, but it also leaves them open to influence by lobbyists, as is often the case, and opens the door for future administrations to weaken regulations.
The law has no provisions to guide regulators if U.S. companies decide to take their business to countries with less-onerous regulations. Without a global agreement on how to manage such companies across borders, the United States stands to lose jobs and income.
The legislation doesn't do much to improve how credit-rating agencies assess risky mortgages. It does not reform the largest bundlers of home mortgages into securities, Fannie Mae (FNM, news, msgs) and Freddie Mac (FRE, news, msgs), which were guilty of lowering mortgage standards and which the government was forced to take over.
Consumer protection agency established
A new Consumer Financial Protection Agency will be charged with setting standards on mortgages, as well as credit cards and payday loans (although auto dealers were exempted, a sign of the power of lobbies). But its authority remains unclear -- it sits inside the Federal Reserve, whose main focus is managing inflation and providing stability to the banking sector.Perhaps the strongest reform lies in the Financial Stability Oversight Council. This body will try to bridge the interests of many regulatory agencies and see the financial landscape as a whole, preventing bubbles in any part of the economy. But its exact scope is left up to the appointed officials.
Second in importance to the council is a requirement for transparency in the multibillion-dollar derivatives industry. This type of financial instrument, now conducted largely in secret between private parties, will now be put on public exchanges. Bringing this shadowy practice into the light should help identify systemic risks in the economy.
Congress was under political pressure to rein in Wall Street's worst practices before this fall's elections. And Obama claims the reforms "can help prevent another financial crisis like the one that we're still recovering from."
But so much has been left hanging that voters will have to decide if lawmakers made the right choices. Taking the biggest risks out of financial markets isn't easily done when so much about this law remains at risk.
