After the worst economic crisis since the Great Depression, congressional lawmakers are nearing an agreement on how to revamp the U.S. financial system and protect consumers from future problems.
Key members of the Senate Banking Committee, after months of negotiations, are expected to unveil their proposal within the next week, people familiar with the negotiations said. While the sources cautioned that no agreement had been reached, the lawmakers, led by the panel's chairman, Sen. Chris Dodd, D-Conn., are considering a new plan to entrust the Federal Reserve with protecting consumers from abusive financial industry practices.
If the senators can reach an agreement on how to shield consumers from the perils of the financial system, it would signify a massive step in the push to enact the most sweeping regulatory changes on Wall Street since World War II. No single issue in the overhaul effort has caused more controversy than the proposed consumer protection agency.
The White House proposed in June a stand-alone unit and the House of Representatives passed a bill to create one in December, but the proposal has divided the key players in the Senate for months. Lobbyists for the financial industry, as well as numerous Republicans, have fought vigorously against the idea, warning that it would stifle innovation in the financial industry.
The latest proposal to house the consumer protection unit within the Federal Reserve came days after Dodd suggested putting it in the Treasury Department under the name of a "Bureau of Financial Protection."
It remains to be seen what will win the support of Republican senators such as Richard Shelby of Alabama and Bob Corker of Tennessee, but financial industry sources said they expect Dodd's eventual proposal will place the watchdog within another federal regulator, rather than create a new stand-alone agency.
The expected compromise by Democrats and the White House prompted concerns among critics, led by Elizabeth Warren, the head of the Congressional Oversight Panel and a leading voice in calls for an independent consumer watchdog.
"What matters is the independence," Warren said. "If the agency is not independent, there's really not much point."
Critics: Consumer Protection Agency Must Be 'Independent'
But Warren might approve of the watchdog being housed within another agency as long as it is given sufficient power to act independently. That was similar to the response from the White House to Dodd's latest proposals. President Obama's spokesman Robert Gibbs argued that the proposed consumer protection unit's success will not be dictated by its ultimate address, but rather by its independence.
"Most importantly, the [agency] has to have strong independent authority, an independent head, an independent budget, independent authority to do what it needs to do," Gibbs said Monday.
Other consumer advocates, however, have warned that only a completely independent consumer protection unit can be entrusted to get the job done.
"A fully independent agency is critical if we are to have true reform," Pamela Banks, senior policy counsel for Consumers Union, said. "We can't rely on the same regulators in Washington to protect consumers when they failed to protect us in the first place."
Bill Isaac of LECG Global Financial Services said, "A lot of folks failed in the buildup to the current crisis. The Securities and Exchange Commission's performance was abysmal. The Treasury dropped the ball significantly and the Fed did as well.
"I think it's time for significant reforms to our regulatory system. To hand this consumer protection job to the Fed is contrary to the direction we need to be going in.
"It really amounts to moving the deck chairs on the Titanic by maybe a foot or two," he said.
Dodd's latest proposal to entrust the Fed with protecting consumers came as a surprise. The Connecticut lawmaker had been outspoken about the Fed's failures to shield Americans from the perils of the financial industry, even proposing legislation last year that would have slashed the central bank's powers.
So many senators blamed the Fed for the country's financial meltdown that the reconfirmation of central bank chairman Ben Bernanke once appeared to be in serious jeopardy. Now, however, in an effort to strike a bipartisan agreement with Republicans, Dodd appears ready to compromise if it means overhauling a financial system that sent the U.S. economy spiraling into recession in late 2008.
Sen. Dodd Central to Reforms' Passage
Giving the Fed additional consumer protection responsibilities would only add to what is already shaping up as a major restructuring at the central bank. Donald Kohn, second-in-command to Bernanke, said Monday he would retire in June, meaning that Obama will have three vacancies to fill on the Fed's board.
But critics warn that as the Fed is reshaped this year, the central bank should be given less power not more.
"I am very concerned about giving the Fed more things to do," LECG Global's Isaac said. "It seems that over the past half century, every time we haven't known what to do with something, we toss it in the Fed. It dilutes its mission, distracts it away from its primary function to conduct monetary policy, and helps to politicize the agency, which needs to be completely free of the political process. … It's been given so many missions that it can barely perform them all properly.
"My biggest fear," he said, "is we are going to take the politically easy route and we're going to wind up not making meaningful reforms and these problems are going to come back to haunt us again."
Time, though, may not be on the side of Isaac, Banks, Warren and other critics concerned that the eventual overhaul will not do enough to crack down on harmful Wall Street practices.
Because Dodd is not seeking re-election in November, he may be compelled to act swiftly to enact a measure before he leaves Capitol Hill.
"All of us, regardless of what your political party is or affiliation, we cannot allow this to happen again," Dodd told his Senate Banking colleagues at a hearing earlier this month.
Key administration officials also want to see action sooner rather than later, as evidenced by White House chief of staff Rahm Emanuel's warning that "you never want a serious crisis to go to waste" and Treasury secretary Tim Geithner's statement that "time is the enemy of reform."
"The president is very determined here to put in place a financial reform where we will avoid what is the story of the last generation," Obama's top economic adviser, Larry Summers, told CNBC Monday. "It's a crisis almost every three years, and surely we can do better."
To date, nothing has been done to protect the Americans from once again falling prey to the perils of Wall Street. Wall Street firms can still engage in the trading of murky derivatives such as credit-default swaps, the biggest firms have only gotten bigger after receiving hundreds of billions of dollars in bailout money, and Washington still has no way to monitor systemic risks to the economy or to wind down a massive failing firm.
Can Washington Act to Avoid Another Financial Crisis?
Peter Wallison, senior fellow at the conservative American Enterprise Institute, blamed the lack of overhaul thus far on the Obama administration's releasing an initial proposal last summer that was too strict and ambitious.
"What the administration proposed was really unacceptable to many many people in Congress, and not just Republicans; Democrats also," Wallison said. "Twenty-seven Democrats in the House voted against [Massachusetts] Rep. Barney Frank's edition, which was essentially the administration's plan."
"That showed this was not a partisan case, it was a case of the administration over-reaching. And now they're having even more trouble in the Senate, where the Banking Committee is very unhappy with what the administration proposed and is making a lot of changes."
That 18 months after the financial meltdown nothing has changed has sparked concerns that another meltdown could be on the way.
"Absent meaningful reform, we are still driving on the same winding mountain road, but this time in a faster car," Neil Barofsky, the special inspector general for the $700 billion Troubled Asset Relief Program, warned in a report released last month.
Now, as the White House and Congress move closer to taking steps to prevent another crash, the key question remains: Will a Washington divided on how to overhaul the ways of Wall Street and gridlocked by partisanship manage to succeed in protecting Americans from a repeat of the recent crisis?
The answer could still be some time off. Even if the eventual proposal from the Banking panel garners enough support to make it through the Senate, lawmakers will still have to reconcile the bill with the version passed by the House before both branches of Congress vote on the final measure.