Reform Without Punishment

The Senate's passage Thursday night of far-reaching financial reform is being portrayed as a big loss for the financial sector. "No End to Banks' Capitol Punishment," reads the headline in The Wall Street Journal. But everything's relative. The legislative action is a defeat in large measure because Wall Street wanted no reform. And it seems like harsh punishment because the default situation for the last 30years has been that the financial sector gets precisely the regulation it wants.

Given what the financial sector put the nation through in the past three years, the case for punitive action was—and is—very compelling. But while there's stuff in there that the financial sector doesn't like, the legislation that is now headed to a House-Senate conference is, in fact, relatively tame.

Consider what's not in the bill. Earlier this year, President Obama came out in favor of the  Volcker rule, which would have prohibited regulated banks from engaging in the enormously profitable (but risky) business of proprietary trading. That would have punished the large investment banks. It is not part of this legislation. There's been some discussion of a  Tobin tax, the idea of levying a tax on financial transactions such as currency, stock, and derivative trades. That would raise revenue and provide disincentives for the socially useless algorithmic trading that creates risk for all investors. That would have punished many financial institutions. It is not part of the legislation. The House version of financial reform called for a $150 billion fund to be raised, largely by taxing big financial institutions, that would help wind down failed institutions. That would have exacted a significant (and, to my mind, justified) cost on big investment banks. It is not part of the Senate legislation. If health-care reform is any guide, the dynamics of Capitol Hill suggest that most House-Senate disputes are likely to be resolved in favor of the Senate.

Some of the most absurd prerogatives and loopholes are left untouched. This bill doesn't address carried interest, the absurd state of affairs under which private equity and hedge funds the ability to pay capital gains tax rates on money they make managing money for other people.

There are some  areas in which the Senate goes further than the House. The Senate bill would, as The New York Times reports, "force big banks to spin off some of their most lucrative business into separate subsidiaries." And the legislation would push most derivatives trading onto exchanges, a move that would bite into the existing profits of some financial firms. (It's difficult to see how greater transparency and liquidity in a massive market hurts the industry as a whole.)

Of course, oversight and regulation are always seen as negatives by the industry. But as I've argued, industry frequently doesn't know what's best for it. The bill that's emerging doesn't tax trading, doesn't force the industry to fund its own recklessness in advance, and preserves vital tax breaks, and that puts consumer protection under the auspices of the Federal Reserve, a generally conservative institution. Punishment? More like a slap on the wrist.

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