Senate passes financial reform. Will it help the economy?

President Obama is set to sign the financial reform bill into law soon, but critics worry it will stifle the flow of credit that is key to economic recovery.

By , Staff writer

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    House Speaker Nancy Pelosi (D-Calif.) signs the Financial Reform Bill at a bill enrollment ceremony after the Senate passed the bill on Capitol Hill in Washington, Thursday.
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The Senate passed major financial reforms, in a 60-39 vote, Thursday, sending the legislation intended to overhaul the regulatory system to President Obama for his signature.

The question that remains is whether it will help prevent future financial crises – and whether it can achieve that objective without curtailing the flow of credit that will be vital to economic recovery.

Many finance experts say that, on balance, the bill is a step forward. But they add that it doesn't eliminate the risk of a new crisis or the prospect that large banks could reap bailouts during such an emergency.

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Some critics of the measure have a different concern: that ramped-up regulations of the financial sector could crimp lending activity at a time when the economy is still struggling to get back into growth mode after the harshest downturn since the 1930s.

The financial reforms have enormous scope, even though some critics on both the left and right say important elements are lacking. It will:

• Set up an oversight council of top financial regulators to watch for "systemic risks" among banks, insurance firms, and other companies involved in the flow of loans or risky assets.

• Empowers regulators to take over a large financial firm that's on the brink of collapse, with the goal of dismantling it in a way without spreading wider chaos in the economy. Financial firms themselves, not taxpayers, would pay any costs involved.

• Creates a new bureau of consumer protection, designed to better promote transparency and safety in things like mortgages just the way federal agencies do on things like foods.

• Calls for tighter oversight of a range of activities outside traditional lending, which affect the health of the financial system. These areas include hedge funds and the complex investment contracts known as derivatives.

The Senate's vote came after a year of wrangling in Washington over how to safeguard the nation from the sharp economic decline in 2008, causing double-digit unemployment. Joblessness surged even in communities that had not seen a housing bubble or a foreclosure wave.

Debate in the Senate chamber Thursday underscored the differing views on how financial reform will affect the economy. The lawmakers echoed the opinions, pro and con, that are shared by many economists.

Republicans, who voted heavily against the bill, warned that new regulations will mean tighter credit conditions at precisely the wrong time. Senate Minority Leader Mitch McConnell (R) of Kentucky said the measure will "stifle growth" and "kill more jobs."

Democratic backers of the legislation argued that what's hampering the economy now are the lingering effects of the 2008 financial shock, not uncertainty about heightened regulation. They say tighter oversight of finance needed to revive shaken confidence in US markets.

"We had a crisis here that practically destroyed the country, that practically destroyed the world," said Sen. Ted Kaufman (D) of Delaware. He wanted to make the bill even tougher. "The bill delegates too much authority to regulators," he said, rather than limiting risky behavior and curbing the size of banks that are now deemed "too big to fail."

The tension between promoting lending and promoting prudence goes beyond America. US officials are meeting with other nations to try to harmonize new regulations, so that imprudent lending can't find a haven in one nation and then contaminate the world economy. But the process, at the Bank for International Settlements in Basel, Switzerland, is influenced by concerns that tighter rules will hamper fragile economic growth.

Another central debate over the US bill is whether it will reduce the problem of "too big to fail," in which the largest banks may be more prone to take risks because they believe they will be rescued in a crisis.

The bill seeks to ensure that taxpayer-funded bailouts end. But it also allows that, amid risks to the overall banking system, officials can approve backstop guarantees to stem a panic. In effect, critics say that could become a taxpayer bailout by another name.

Still, the measure may at least mean that investors in large banks – including bond-holding creditors as well as shareholders – lose money if the firm fails.

"I believe it will pretty much bring an end to the concept of too big to fail," said Sen. Judd Gregg (R) of New Hampshire. He said he opposed the bill because of other concerns. Senator Gregg said that credit availability may falter as regulations proliferate, and that the new emphasis on consumer protection may hurt consumers by driving up loan costs.

Already, regulators have felt pressure in recent months to strike a careful balance. They are trying to enforce prudent standards while also encouraging banks to make new loans that are needed for the economy to recover.

Sen. Christopher Dodd (D) of Connecticut, the committee chairman who shepherded the bill to completion, stopped short of saying the measure will keep a financial collapse from occurring again. His hope, he said, is that the financial reforms will give policymakers the tools they need to contain its size and damage.

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