Reporting from Washington and Los Angeles — The financial reform legislation might change how Wall Street does business, but it would hardly put Wall Street out of business.
The measure that emerged from a House-Senate conference committee would push banks to make their trading in complex securities known as derivatives more transparent and to cut back on some of the risky trading that triggered the financial crisis. It would also give regulators new powers to oversee lightly regulated financial firms, including hedge funds and insurers.
But though the legislation would put new limits on Wall Street banks, it wouldn't outright bar many of their activities — including rapid-fire stock and bond trading and the packaging of complex securities to hedge their investment bets.
"After the dust settles, and they've crossed all the Ts, there's probably not going to be much difference in how the banking industry looks — that's the long and short of it," said Raymond Stewart, chief investment officer of Rasara Strategies, which specializes in investing in the financial sector.
Moreover, the legislation leaves largely untouched some of the biggest concerns about the financial industry that grew out of the mortgage meltdown and the resulting credit crisis. These include worries that banks have grown so powerful that they are "too big to fail," and that Wall Street's pay system — built on the annual bonus — has made short-term trading profits the primary focus.
Sheila Bair, head of the Federal Deposit Insurance Corp., said that many of the measures that most scared the banks — including provisions to restrict trading of derivatives — ended up being scaled back in the legislative scrum.
"I think they are breathing a sigh of relief today because the derivatives piece ended up being much less onerous than they originally expected," Bair said. "It could have been a lot worse."
Reflecting that sentiment, financial stock indexes jumped almost 3% after sinking about 15% in the last two months.
The country's giant banks do expect to feel bottom-line financial pain from the legislation, including from restrictions on so-called proprietary trading, in which a bank trades stocks, bonds and other securities for its own profit, not on behalf of a client.
Restrictions on proprietary trading and derivatives trading would affect Goldman Sachs Group Inc. the most of any Wall Street bank, according to one estimate, cutting its earning power by up to 23%.
"In the short run you're going to have some pressure on your revenues — and some pressure on costs," said Matthew Warren, a financial industry analyst at research firm Morningstar. "In the long run, though, it's just not going to be that different."
The legislation will go to the full House and Senate for floor votes next week, and President Obama has said he hopes to sign the bill by July 4.
In one major change, the legislation provides for a council of regulators that would have the ability to wind down financial institutions that end up in trouble and that are deemed "systemically significant" — such as insurance companies.
But the overhaul legislation wouldn't force big banks — the target of much public criticism during the crisis — to shrink.
In contrast, in the 1930s, the landmark Glass-Steagall Act forced banks to separate their riskier investment banking operations from their commercial banks, which predominantly take deposits and make loans. The idea was to protect commercial banks, which are backed by federal deposit insurance, from devastation during financial crises. The Glass-Steagall provision, however, was repealed in 1999.
Moving back in the direction of Glass-Steagall, the Obama administration proposed the so-called Volcker rule, developed by former Federal Reserve chief Paul Volcker. The rule was one of the most contentious elements of this week's negotiations. The final compromise limits banks to investing no more than 3% of their capital in hedge funds, private equity funds and proprietary trading desks.
On derivatives, the banks would be forced to move some particularly risky trading into separate entities. Virtually all derivatives would have to be traded through a clearinghouse, bringing down some of the profits from the private derivatives deals in which the banks currently engage.
Among the measures that reformers wanted to see — but that were not included in the bill — was an independent oversight board to address conflicts of interest in the debt-rating industry. Firms such as Standard & Poor's and Moody's have been blamed for bestowing bullish grades on mortgage-linked securities that subsequently plummeted in value during the housing bust.
The Senate bill would have created an oversight board, but congressional negotiators last week agreed to drop that provision, opting instead for a study by the Securities and Exchange Commission along with a slightly easier path for investors to sue the rating firms.
The legislation also doesn't deal with Fannie Mae and Freddie Mac, the government-sponsored mortgage finance giants that have been blamed for contributing to the mortgage meltdown.
"The big hole here is that nothing is being done about Fannie and Freddie," said Robert Pozen, chairman of MFS Investment Management and a senior fellow at the Brookings Institution. "And that is a huge hole."