7 Reasons to Be Skeptical About Financial Reform

Number 7: We failed to kill 'Too Big to Fail.' In fact, we might have even made it stronger.

Financial reform is an Obama signature away from becoming law in the United States, after the Senate voted to overhaul the rules and regulations governing the nation's banking system. Democrats will no doubt hail the bill as a major accomplishment before the midterm elections. After all, it is perhaps the most significant piece of progressive financial legislation since the Great Depression.

But the Atlantic has also spent considerable time pointing out all the ways financial reform could fail to curb risk appetite, strengthen the most dangerous banks and hurt ultimately taxpayers. Here* are seven reasons to be skeptical about financial reform:

1. The Bill Has Lobbyists' Finger Prints All Over It. Perhaps one of the most egregious lobbyist influences was a key exclusion from the Consumer Financial Protection Bureau. When you think about consumer credit, a few products immediately come to mind: mortgages, car loans, and credit cards. But wait! Car loans -- one of the most prevalent types of consumer loan -- are excluded entirely from the Bureau's reach. While it isn't likely that auto loans will ever cause a financial crisis, neither will credit cards. Yet there are certainly auto loan shops that could use dastardly tactics worthy of as much attention as the regulator pays to credit card companies.

2. The Bill Doesn't Deal With Fannie, Freddie, Credit Runs, or Leverage. Fannie and Freddie played a huge role in helping to overheat the U.S. mortgage market. Until those agencies experience some fundamental change in policy and procedures, it's hard to see how another housing disaster won't occur again in the future. There's no attempt at any reform for these companies in either of Congress' financial regulation proposals.

3. Community Banks Are Afraid FinReg Will Hurt Them, Too. Most of the worries of community bankers boil down to a general problem with regulation: compliance with new rules requires that additional expenses are incurred. For a large company, these new costs aren't as harmful. They benefit from economies of scale -- an advantage where new fixed costs can be more easily absorbed by a larger company's higher profits.

For example, imagine two widget factories: one big one that employs 5,000 people and a small one that employs just five. If a new regulation requires all widget-makers to hire one person in charge of monitoring quality control, the big company's labor costs increase by 0.02%, while the smaller firm's labor costs increase by 20%. Smaller companies take a much bigger hit to their proportionally smaller earnings when additional regulation is imposed.

4. Financial Reform Won't Protect Taxpayers From a Future Bailout. If financial reform accomplishes anything, it should minimize the cost to taxpayers of future financial crises. But looking at the bailouts that Americans will be on the hook for, it fails that very basic test. And this isn't really a controversial point, since it does nothing to reform the government-sponsored entities (GSEs) Fannie Mae and Freddie Mac. [Via Bloomberg:] "The White House's Office of Management and Budget estimated in February that aid could total as little as $160 billion if the economy strengthens."

5. A Derivatives Loophole Could Cost Main Street $1 Trillion. From the International Swaps Dealers Association statement: "A change in the wording of the financial reform bill now being finalized in the US Congress could cost US companies as much as $1 trillion in capital and liquidity requirements, according to research by the International Swaps and Derivatives Association, Inc. (ISDA). About $400 billion would be needed as collateral that corporations could be required to post with their dealer counterparties to cover the current exposure of their OTC derivatives transactions. ISDA estimates that $370 billion represents the additional credit capacity that companies could need to maintain to cover potential future exposure of those transactions. If markets return to levels prevailing at the end of 2008, additional collateral needs would bring the total to $1 trillion."

6. Can You Trust a Bill That Requires 79 Years of Cumulative Studies? Reform isn't easy. Beyond making tough decisions, it also apparently involves an awful lot of research. The 3,321 pages of financial regulation bills being melded together by Congress' conference committee contain an incredible number of studies to be completed: 74. Approximately four of the studies are nearly identical. The other 70 all investigate different aspects of finance, economics, lending, etc. If you add up all the time allotted for these studies to take place, and did them back to back instead of simultaneously, then you'd be doing studies for almost 79 years.

7. We Failed to Kill 'Too Big to Fail.' In Fact, We Might Have Made It Stronger.  What happens when lots of banks start to fail together? The liquidation process will be so onerous and ugly that in future severe crises where we've got widespread problems in the industry with multiple systemically crucial banks -- the once-every-three-generations kind of catastrophes -- the government might not have the stomach for widespread liquidation. "Think about it this time around," says Brookings' Doug Elliott. "If they had to take down Citi and Bank of America and the law required them to liquidate these guys, it would have been a disaster. And we would have created TARP."

*Atlantic Business reporter Daniel Indiviglio wrote pieces 1-6. Derek Thompson wrote number 7.