WASHINGTON — Rushing to deliver the broad strokes of an overhaul of the financial regulatory system before leaders of the world's major economies meet in Toronto over the weekend, lawmakers Friday morning partially reinstated a ban on risky betting by commercial banks.
In a marathon session, negotiators from the House of Representatives and the Senate reached a compromise that would limit commercial banks from engaging in Wall Street trading if they're also conducting trading activities on behalf of clients.
Senators agreed on this provision late Thursday, and final agreement came overnight.
"The progress made over the past two weeks is enormously important for the country and provides crucial momentum for global financial reform," Treasury Secretary Timothy Geithner said.
"After great debate we have reduced a strong Wall Street reform bill that will change the way our financial services sector is regulated," said Sen. Chris Dodd, D-Conn., the legislation's principle proponent and chairman of the Senate Banking Committee.
Separation between deposit-taking commercial banks and so-called proprietary trading had been in effect since the Great Depression under the Glass-Steagall Act of 1933. However, deregulation in recent decades weakened that traditional separation and the act was repealed in 1999.
The repeal helped spark outsized risk taking on Wall Street that led to the financial crisis of 2008 and subsequent deep recession. Restoring parts of the ban became a mission for Democrats, but it proved to be among the most controversial elements of new rules for Wall Street.
Efforts to restore at least partial separation between commercial banks and Wall Street speculation has become known as the Volcker Rule. Former Federal Reserve Chairman Paul Volcker, an adviser to the Obama administration, championed the concept over Geithner's reservations.
Under the compromise Dodd first announced Thursday, deposit-taking commercial banks could still invest in hedge funds and private equity funds, but their participation in these high-risk funds would be limited. Banks could own no more than 3 percent of such funds, and the investment couldn't exceed 3 percent of the bank's capital.
The move to allow some bank investment in hedge funds was intended to win support from Sen. Scott Brown, R-Mass., according to an industry official who requested anonymity because of proximity to the negotiations. Brown, one of four Republicans who supported the broad Senate bill, seeks flexibility for Boston-based bank State Street, which has asset-management funds that could be affected by the restrictions.
Dodd said he sought to balance the need to limit risky betting by banks and the need of banks to hedge some of the risks they face in their lending business.
"We tried to strike a balance," said Dodd.
He said he incorporated ideas from Sens. Carl Levin, D-Mich., and Jeff Merkley, D-Ore., who'd spent weeks lobbying colleagues for a strong wall between commercial and investment banking.
Investment banks such as Goldman Sachs and Merrill Lynch flourished in an era of deregulation, until 2008, when Bear Stearns was sold in a brokered fire-sale deal by regulators in March, followed by the collapse of Lehman Brothers six months later.
To avoid a similar fate, surviving investment banks moved quickly to become bank holding companies and qualify for taxpayer rescue funds. Merrill Lynch was acquired by Bank of America, at the time the strongest commercial bank.
Agreement on the Volcker Rule cleared the path for overnight negotiations on the thorniest portion of the legislation, a requirement that commercial banks spin off their trading operations for derivatives, a market of lightly regulated and highly complex financial instruments valued in the trillions of dollars.
The tougher derivatives language was in the Senate version of the legislation, but not in the House's, and the issue divided Democrats into camps. Moderate House Democrats threatened to withhold support from a final bill if the provision stayed, while liberal Senate Democrats threatened the same if it was dumped.
"This bill gets weaker by the day," complained Sen. Byron Dorgan, D-N.D., the chairman of the Senate Democratic Policy Committee.
The compromise will require banks to spin off their riskier investments, but maintain trading in instruments tied to interest rates and foreign currencies.
It was unclear how the compromise would affect passage of the bill. Key Democrats have threatened not to support the bill if it doesn't contain tough derivative language. However, if the 59 moderates in the New Democrat Coalition withhold their support, it could derail passage in the House, too.
Before addressing those two most difficult issues, negotiators agreed to numerous compromises. They allowed banks to escape prepaying billions of dollars into a fund to dissolve other banks whose failure could bring down the entire financial system.
In a blow to consumer advocates, lawmakers agreed that auto dealers who offer financing to customers should be exempt from direct regulation by a new Bureau of Consumer Financial Protection. The Pentagon took the unusual step of writing letters to negotiators calling for tougher regulation of auto lending, citing predatory lending practices aimed at members of the armed services.
Although he opposed the exemption for auto dealers, Rep. Barney Frank, D-Mass., the chairman of the House Financial Services Committee, conceded Thursday afternoon that he lacked the votes to block it.
Also to the ire of consumer advocates, lawmakers accepted a Senate compromise that would order the Securities and Exchange Commission to study for six months a rule to require everyone who provides investment advice to act in the best interests of their clients. Currently, financial advisers have this fiduciary duty, but broker-dealers and insurance agents who sell financial products don't.
Consumer advocates retained one ray of hope, however. The compromise would allow the SEC to begin a rulemaking process to impose such a standard if it sees fit.
"We expect the agency to stand up for Main Street investors," said Denise Voigt Crawford, the Texas Securities Commissioner and the president of the North American Securities Administrators Association.
Negotiators also agreed to end the practice of self-funding for the SEC. The SEC and its counterpart Commodity Futures Trading Commission would have to submit their budgets to Congress and the executive branch, and their funds would be appropriated by lawmakers. And lawmakers agreed to grant the SEC the authority to set up rules giving large shareholders more influence on corporate boards.
In another point of negotiation, senators pared back a House proposal that would have provided $3 billion, through the Department of Housing and Urban Development, to help unemployed homeowners with good payment histories to stay in their homes. The Senate negotiators counter-offered with $1 billion. House members were to respond overnight.
"I would have liked to have done more for homeownership, for neighborhoods," said Rep. Maxine Waters, D-Calif., a senior House Financial Services Committee member. "It's important to stabilize communities ravaged with foreclosures."
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