The political battle over regulating Wall Street

What happened

Senate Democrats brought a financial reform package to the floor this week, after portraying filibustering Republicans as defenders of Wall Street. The jockeying unfolded in an atmosphere of recrimination against the financial industry, as executives from Goldman Sachs endured 10 hours of harsh questioning by a Senate panel investigating Goldman’s business practices. Goldman CEO Lloyd Blankfein said the Securities and Exchange Commission’s recent accusation that his firm had engaged in fraud was “one of the worst days of my professional life,’’ and he maintained that Goldman’s clients understood the risks they were taking on. But Democrats charged that Goldman knowingly sold derivatives based on bad mortgages and then bet they would lose value, thus helping to create the 2008 economic collapse. After three days of blocking a vote on new regulations, meanwhile, Republicans agreed to let legislation reach the floor, where they hoped to amend it. “I remain deeply troubled by a number of provisions in this bill,’’ said Senate Minority Leader Mitch McConnell.

Republicans said they had won some concessions from Democrats in negotiations, including the elimination of a $50 billion fund designed to “wind down’’ failed institutions. Disagreements remained on the best way to regulate derivatives, the financial instruments that allow investors to bet on the direction of prices of stocks, mortgages, and other assets. Senators in both parties are expected to offer numerous amendments, and the final bill must be reconciled with a reform bill that passed the House in December. Democratic Sen. Chris Dodd promised that new regulations would “create a sound foundation for our nation’s future economic strength,” saying, “It’s time for this debate to begin.”

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What the editorials said

The prospects for reform got a boost this week from “America’s pre-eminent investment house,” said TheEconomist.com. Public testimony by Goldman Sachs chief executive Lloyd Blankfein and other executives provided “no smoking gun,” but helped senators paint Wall Street firms as immoral, profit-seeking sharks. Blankfein seemed “baffled” at the outrage over derivatives and the massive losses suffered by those who bought them.

Goldman is a convenient scapegoat for Democrats, said The Wall Street Journal. To find the “root causes of the crisis” on Wall Street, Congress should focus its attention on the “toxic twins”—Fannie Mae and Freddie Mac. These and other government entities were responsible for more than $2.7 trillion in bad mortgages—“three times Goldman’s entire balance sheet.” Yet the Democrats’ plan includes “no reform of Fannie and Freddie.”

What the columnists said

Rather than quibble with Democrats over details of reform, said Matthew Continetti in TheWeeklyStandard.com, the GOP should demand an even stronger bill. Why not “break up the banks” into smaller entities or “raise Cain about the rating agencies” that certified junk mortgages as AAA investments? Some “structural changes” make sense, said Terry Savage in the Chicago Sun-Times, such as returning to the “separation of banking and investment activities” that kept the banking system sound for 70 years before deregulation in 1999. But only by adopting a government-planned economy like that of Cuba or the old Soviet Union can the U.S. avoid the booms and busts inevitable in free markets.

The real problem is the financial industry’s “skewed incentives,” said James Grant in The Washington Post. Executives would be far more responsible if they knew that they would be held personally liable for losses incurred by banks and investment firms, with their homes, boats, cars, and other assets being sold off to pay creditors. In Brazil, when a bank fails, directors, senior officers, and controlling shareholders lose everything they’ve got. Now that’s how you “bring the fear of God back to Wall Street.”

A little adult supervision would suffice, said Bethany McLean in The New York Times. The 2008 meltdown was above all a failure of oversight. After refusing to regulate derivatives, and repealing the Glass-Steagall Act separating investment and commercial banking, Congress “sat by idly as consumer advocates warned that people were getting loans they’d never be able to pay back.” Senators clearly enjoyed bellowing at Goldman executives for their reckless ways. “Shouldn’t Congress have its turn on the hot seat as well?”