Assessing Winners and Losers in Final Reform Bill

WASHINGTON — Those looking for clear winners and losers after the conference committee struck a historic final agreement early Friday on regulatory reform legislation are bound to be frustrated.

For every agency or industry participant that appeared to gain in the bill, there was a downside, while those who arguably emerged bruised and battered after the epic deliberations narrowly avoided an even worse fate.

The Federal Reserve Board, for example, which will gain a host of new powers, now faces a task that many would consider impossible: preventing the next crisis. Meanwhile, the largest banks, which were the targets of just about every provision of the legislation including a tax added in the final hours of debate, escaped the harshest measures designed to cripple or break them up.

"You could look at the list, and even if you're included on the winner side of the column, you would find that there are issues where even a winner had a very significant loss," said Ray Gustini, a partner at Nixon Peabody.

Still, some players finished far ahead of others. The Fed began the reform process as the whipping boy for the financial crisis, and faced a serious effort to strip it of its banking supervisory authority, only to emerge at the end with systemic-risk oversight and power over interchange rates for debit cards.

The Federal Deposit Insurance Corp., too, won battles for resolution powers over large, systemically important firms and long-sought capital restrictions.

Community banks also ended mostly in the plus column, exempted from enforcement by the new consumer protection agency and many of the other restrictions in the bill, while larger banks face new curbs on trading and derivatives activities.

"The money-center banks came out perhaps the worst in this legislation," said Douglas Landy, a partner at Allen & Overy. "They have significantly higher regulatory standards, both prudential and quantitative, and their business model is really being questioned."

But everyone took their lumps, and observers said large banks avoided what could have been a more rapid transformation of their structure similar to the reforms made under the Glass-Steagall Act after the Great Depression.

"Nobody has done anything to break up the big banks," said Roberta Karmel, a former Securities and Exchange commissioner and now a professor at Brooklyn Law School. "The big banks were winners whether they know it or not. Everybody likes to say … small banks are so important for capital formation. But in the end, the big financial institutions won out."

Perhaps as a result, large bank stocks mostly traded higher on Friday despite several new restrictions added as part of the reform bill.

And even though the FDIC and community banks came out stronger, they lost crucial battles. The agency at one point seemed likely to become the federal overseer of all state-chartered banks and to gain oversight of some holding companies, yet the Fed retained authority over that sector. The FDIC did gain backup authority over holding companies, similar to its backup authority over banks.

The FDIC also failed to get lawmakers to create a resolution fund to help it unwind a systemically vital firm. The Houses passed the measure, but it was not adopted by the Senate or the conference committee.

"The elimination of a prefunded systemic resolution fund, which the industry would have to fund, to me is a huge win for the 'too big to fail' players, and a huge loss for the FDIC and taxpayers," said Arthur Wilmarth, a George Washington University law professor. "That is the first provision that the industry focused on in terms of getting it out of the House bill."

Likewise, although community banks won a permanent increase in the deposit insurance limit and two-year extension of the Transaction Account Guarantee, they lost a fight to prevent the Fed from imposing interchange restrictions on debit card issuers and the softening of federal preemption powers.

Preemption proved a mix bag for the Office of the Comptroller of the Currency as well. On the one hand, the agency helped beat back the Obama administration's initial proposal, which would have eliminated preemption entirely. On the other, the final bill makes it harder for the OCC to preempt state consumer laws and would let state attorneys general enforce some federal standards against national banks.

Still, the OCC also gained somewhat from the bill, garnering oversight of thrifts after the Office of Thrift Supervision is eliminated.

"Regulatory head count is power in many ways, but they also obviously had some losses, preemption being the big one," Gustini said of the OCC. He added that community banks also failed ultimately to remove "too big to fail" from the national vocabulary.

"Community banks won some and lost some," he said. "They will perhaps get the increased deposit insurance that they wanted. On the other hand, regardless of what people say the concept of 'too big to fail' has not been wiped out and will continue to give the big banks the funding advantage that they've enjoyed for so long.

"The relative difference between big banks and small banks perhaps hasn't changed that much."

Steve Verdier, director of congressional relations for the Independent Community Bankers of America, said the legislation "will increase the burden on community banks particularly in interchange.

"But by us being active participants, we were able to get some carve-outs and the deposit insurance changes," he said. "The community banks did a lot better than big banks, there is no question about that."

Perhaps the biggest net positive went to the Obama administration, which gets another big legislative achievement under its belt, and the Treasury Department, which gained a larger share of the type of financial oversight powers usually reserved for independent agencies.

"In contrast to health care, the administration put out a clear premise of what they wanted to get done" in financial reform "and the outcome was pretty close," said Raj Date, the chairman of the Cambridge Winter Center for Financial Institutions Policy. "Whether or not you thought the blueprint was a good one, it's a clear win for the administration. It would have been difficult to head into the midterms more than three years after the crisis began and still not have gotten anything done."

Under the bill, the Treasury will also be able to assert itself as more than just an arbiter of financial policy, chairing a new council meant to oversee systemic risk and becoming the key decision maker of whether a systemically important nonbank is placed into an FDIC receivership.

"If you're looking for one winner, I would say it's Treasury," Landy said. "If you look at the final bill as compared with what they originally proposed, it's remarkably similar. … And there's a significant amount of regulatory discretion that has been either transferred to Treasury or made subject to Treasury" approval.

"Treasury has really come to a very dominant position over what used to be a very independent set of regulatory agencies."

Of course, the biggest comeback among the players in the legislative debate was mounted by the Fed.

Blamed for being asleep at the switch as mounting risks in the system led to the crisis, the central bank ultimately has been trusted with primary oversight of the biggest financial companies, while losing virtually none of its existing powers.

"There was a point in this debate where it seemed it would just be slimmed down to just a custodian of monetary policy, and if anything the Fed's power has been enhanced in a resounding fashion," Date said.

Other observers said the Fed's victories could be bittersweet, since the central bank — still trying to explain its perceived failings leading up to the mortgage debacle — now faces the gargantuan task of proving that the enhanced powers over financial behemoths will work, and could ultimately be blamed if there is a future crisis.

"They don't have the same unblemished reputation they had before, and Congress is going to be emboldened to interfere more in Fed activities," Karmel said.

Landy said the outcome for the Fed in the bill is a "two-sided coin."

"They've been given authority, but they've also been given responsibility for what in essence is an incredibly difficult task," he said. "It's a situation where they will get significantly more blame than credit."

The final hours of the conference committee were dominated by efforts to water down perhaps the most dramatic new restrictions on banks to rein in their derivatives and proprietary trading activities.

The fight over derivatives focused on whether lawmakers would require banks to spin off their derivatives trading desks. In the final compromise, banks will have to conduct some of their derivatives operations in an affiliate, but arguably their most prevalent kinds of swaps, interest rate hedges, can still be conducted in the bank.

Conferees also had to find agreement on provisions of the Volcker Rule, named for former Fed Chairman Paul Volcker, aimed at reeling in proprietary trading. The 11th-hour discussions centered on how much banks could invest in private-equity and hedge funds. The outcome provided for some exceptions, but generally banks could not hold more than 3% of a fund's ownership, and the investment could not exceed 3% of the bank's Tier 1 capital.

Industry representatives were clearly not pleased with the outcome. Adding to their pain, the final negotiations included the addition of $19 billion in taxlike assessments on the largest companies to be collected by the FDIC to help pay for the bill.

"This is a very negative bill for the industry," Ed Yingling, the chief executive of the American Bankers Association, said in an interview. "The biggest loser is the economy, because there is no doubt lending is going to be chilled."

But many observers agreed it could have been worse for the industry.

Wilmarth said a legislative response like that to the Depression, in which the landmark Glass-Steagall legislation imposed severe limits on banks' size, had been a real possibility.

"I can't imagine us going through a crisis of that magnitude and spending the hundreds of billions of dollars we've spent and not have a transformational structural reform that would in a sense largely break up these enormous conglomerates," Wilmarth said. "If banks look back at their brethren in 1933, they have to say, 'We've avoided the bullet those guys took.'"