Why the Brown-Vitter Bill Matters — Even if It Doesn't Pass

WASHINGTON — The conventional wisdom is that the legislation introduced by Sens. David Vitter and Sherrod Brown to tackle "too big to fail" is dead on arrival, facing likely opposition from the Obama administration and the leadership of both political parties.

But even if that's true — and it's almost certainly overstating the case to say the bill is DOA — the legislation is a significant threat to the largest institutions, both now and in the future.

There are at least three reasons why:

1. Another banking scandal could give the bill a burst of momentum
As it stands right now, the bill is unlikely to pass. Regulators are likely to oppose it because it dictates capital requirements and scraps the Basel III process, which could damage international negotiations on a range of issues. Despite small bank support because the bill includes regulatory relief provisions, that is unlikely to provide enough momentum to secure passage in the Senate. The House is arguably a tougher climb.

That has led some analysts to dismiss the bill as a distraction of no significance. Yet the big banks are very concerned about the bill — for good reason.

The history of banking policy is littered with ideas that once seemed radical and then were quickly embraced after a precipitating event left lawmakers looking for a response. When Elizabeth Warren first suggested a consumer protection agency, lobbyists paid little attention to it, assuming the idea would quickly be forgotten. Three years later, the Dodd-Frank law created the Consumer Financial Protection Bureau. Crises have a way of motivating Congress to act — and lawmakers often look to bills that are sitting nearby for inspiration.

If another bank scandal hits — much less a full-blown crisis — the Brown-Vitter bill is a serious attempt to eliminate "too big to fail" and could suddenly look very appealing to lawmakers.

2. The bill's ideas could become part of other legislation
Congress is a factory of recycled ideas. Lawmakers readily borrow provisions of other bills while creating their own omnibus legislation.

The Brown-Vitter legislation itself may not pass, but some of its central tenets might get through the gauntlet more easily. The main thrust of Brown-Vitter is capital, requiring firms with between $50 billion and $500 billion of assets to hold 8%, while larger firms would have to hold 15%. Those numbers may be too high for Congress, but lawmakers could embrace the call for tougher capital standards than the current regime.

The bill also includes what some see as a backdoor restoration of the Glass-Steagall Act, which separated banking from the insurance and securities industries. A provision would restrict affiliate transactions between a bank holding company's banking-related pieces and its non-banking ones. Federal Deposit Insurance Corp. Vice Chairman Tom Hoenig has been adamant that ring-fencing a commercial bank's activities is the key to ending "too big to fail." Such a provision could readily become attached to another bill down the line.

"The concepts in the bill aren't DOA. This could come back in some other form," said one industry source that spoke on condition of anonymity.

Ed Yingling, the former president and chief lobbyist for the American Bankers Association, doesn't think Congress will enact Brown-Vitter. But he acknowledges that another financial reform law that goes beyond Dodd-Frank — and includes some elements of the Brown-Vitter bill — could pass given the right set of circumstances.

"If there were a major event that raised questions about the operations of the largest banks, could there be momentum to do more? The answer to that is yes," said Yingling, who is now with Covington and Burling.

3. Regulators could use the bill as cover
Arguably the largest threat to the big banks has nothing to do with how Congress treats the Brown-Vitter bill. If the bill attracts significant support, it could give regulators more leeway to pursue higher capital and other regulatory requirements.

Federal Reserve Board Gov. Jeremy Stein has already suggested regulators are prepared to continue ratcheting up capital requirements until they change the size and complexity of the largest banks.

"In principle, this turning-up-the-dials approach feels to me like the right way to go," he said in a speech two weeks ago.

Other regulators, including Hoenig and Jeremiah Norton, a board member on the FDIC, are also pushing for regulators to raise the leverage ratio as part of U.S. implementation of Basel III.

The more support that lawmakers show for raising capital requirements, the more power they give those regulators that are already pushing for such changes.

"The more co-sponsors in Congress, the more they can keep it in headlines and the more pressure they can put on regulators," said Edward Mils, a financial policy analyst at FBR Capital Markets, in an interview earlier this week. "The more pressure there is on regulators, the more likely you are to see changes take place."

The impact may go beyond capital requirements. Lobbyists privately say the bill effectively makes it harder to fight other proposed ideas, including requirements for the big banks to issue senior-level debt in order to help the FDIC in a possible resolution.

The cumulative effect of all of this is that Brown-Vitter is likely to have a substantial impact — whether it passes or not.