The most sweeping changes to financial rules since the Great Depression might not prevent another crisis.
Experts say the financial regulatory bill approved by the Senate last week, and a similar bill that passed the House, include loopholes and gaps that weaken their impact. Many provisions depend on the effectiveness of regulatory agencies — the same agencies that failed to foresee the last crisis.
A big reason for the bill's limitations is that banks and industry groups lobbied against rules they felt would reduce their profit-making ability.
The financial sector's influence in Washington reflects its enormous donations and lobbying. Over the past two decades, it's given $2.3 billion to federal candidates. It's outdone every other industry in lobbying since 1998, having spent $3.8 billion.
Here's how the bills, which must be reconciled and approved by the full Congress, might address some causes of the financial crisis, and some of the bill's perceived weaknesses:
The problem: Banks used these investments to make speculative bets that helped inflate the housing market. Once home values crashed, these derivatives — and related side bets — magnified the financial crisis. The value of a derivative depends on the price of an underlying investment. Examples include corn futures, stock options and mortgages.
The solution: The legislation would, among other things, require that many derivatives be traded on exchanges, as stocks are, so they are visible to regulators.
Why it might not work: Business groups led by the U.S. Chamber of Commerce and the Business Roundtable lobbied successfully to dilute the rules. They argued that exchange-trading would make it too costly for companies other than banks to use derivatives.
The bill exempts companies that use derivatives to reduce the risk of fluctuations in interest rates and commodity prices. Experts say this exception could be exploited. Companies could, for example, find ways to combine traditional business activities with purely financial investment through the use of derivatives.
Weak regulation of banks and other financial firms
The problem: Before the crisis, some regulators failed to recognize risks taken by banks they were supposed to oversee. Some companies sidestepped oversight entirely.
The solution: The legislation would eliminate one regulator, the Office of Thrift Supervision, criticized for lax oversight. And it would tighten oversight of large financial institutions that could threaten the system.
Why it might not work: Smaller banks could still choose their own regulator. These banks would likely seek out the most lenient oversight. Key advocates for that loophole were the Independent Community Bankers of America and the American Bankers Association.
The Senate voted against capping how much banks can bet relative to their reserves. It left that up to the same regulators who failed to properly monitor banks' risk-taking before the crisis.
One reason the system of regulators escaped more drastic changes, lawmakers say, was that regulators lobbied to protect their agencies' authorities. For example, Federal Deposit Insurance Corp. Chairman Sheila Bair fought changes that could limit the FDIC's authority.
The problem: After bad bets on housing and other risky investments caused the collapse of Lehman Brothers, the government pumped billions into the largest banks to keep the system afloat.
The solution: The overhaul would let regulators close banks whose collapse could threaten the system.
Why it might not work: The Senate bill lets regulators decide whether to protect the creditors of failed banks. Creditors might take a too-rosy view of a banks' finances if they feel they have nothing to lose in a failure. They might still lend to weak banks and raise the cost of eventually closing them down.
The bill does little to prevent big banks from getting bigger, meaning taxpayers might have to intervene again. A Democratic amendment to limit the size of banks was rejected amid opposition from banks such as Goldman Sachs.
The problem: Risky lending to homeowners who couldn't pay helped inflate the housing bubble. Some of the worst offenders were nonbank lenders.
The solution: A new consumer protection watchdog would police banking products and ban those deemed too risky — no matter who offers them.
Why it might not work: The consumer watchdog's authority would be confined to firms with at least $10 billion in assets. Thousands of community banks wouldn't be supervised by the agency. Nor would many nonbanks.
The Chamber of Commerce has led the push to limit the reach of the consumer agency. The payday lending industry and the National Automobile Dealers Association have joined the effort.
Credit rating agencies
The problem: Credit rating agencies gave safe ratings to high-risk mortgage investments that later imploded.
The solution: The Senate bill would end banks' ability to choose the agencies that rate their investments. An independent board, appointed by regulators, would choose the rating firms.
Why it might not work: The big firms — Standard & Poor's, Moody's Corp. and Fitch Ratings — would still be paid by the banks whose products they rate. That means the ratings could be influenced by those banks.
Others have questioned whether regulators should choose which agencies rate which financial products. Regulators themselves missed warning signs leading to the crisis.