Obama can get everything he wants on financial reform--if only he gets tough.

Last week, Alabama Republican Richard Shelby, the ranking member of the Senate Banking Committee, floated a compromise on the consumer financial protection agency that’s currently stalled in the Senate. Under the bill Chairman Chris Dodd moved through the committee in March, the consumer agency would effectively have its own budget and an independent, White House-appointed director. It would also have significant (but not unchecked) authority to write and enforce rules protecting consumers from abusive bank practices, like deceptive mortgages. Until now, the banks and the GOP have largely tried to eviscerate these provisions. But, according to one person familiar with the discussions, Shelby’s proposal took a big step in the direction of the Dodd approach. (Spokesmen for both senators declined to comment beyond saying that “we continue to discuss a number of options,” as Shelby’s communications aide, Jonathan Graffeo, told me.)

Shelby’s recent outreach seems to reflect the new reality in the battle to tame the banks: Both sides recognize that the reformers have the momentum, given the way last month’s health care victory has unified Senate Democrats, and given the political peril for Republicans in appearing to do Wall Street’s bidding. But both sides also recognize that, p.r.-wise, the consumer agency tends to overwhelm other elements of the reform effort.

In light of this, Republicans seem to be settling on a strategy: Give the Democrats much of what they want on the consumer agency and bet that Democrats won’t be too picky about the rest. If the bet pans out, the industry and its GOP allies would, in effect, be trading a robust consumer agency for a chance to scale back a number of highly consequential but below-the-radar reforms. But will it?


Of course, this being a high-stakes negotiation, no one is prepared to concede much of anything yet—at least not explicitly. When I asked one bank lobbyist last week about a grand bargain involving the consumer agency, I could practically feel him bristle over the phone. “You keep pressing your case until the end,” he insisted.

And yet, the longer you talk to such K Street denizens about the politics of financial reform, the more they concede that this is what the landscape may give them. This same person told me he sensed that Dodd was open to compromising on everything but the consumer agency. He added: "For the average American, it's the only piece of the bill they can really sink their teeth into.”

The logic becomes even more compelling once you home in on particular issues. For example, one of the most important but least understood parts of the financial reform bill relates to derivatives, which are essentially bets on the prices of other assets, like stocks and bonds. The credit default swaps that brought AIG to the government’s doorstep are probably the most famous example of the trouble-making potential of this financial instrument. AIG’s derivatives portfolio was largely a bet on bonds backed by mortgages. When the mortgages took on water, the bet left AIG on the hook for billions in losses, pushing the company to the brink of bankruptcy.

As written, the Dodd bill would require buyers and sellers of derivatives to “clear” them. That means each side would technically trade with a middleman—the clearinghouse—to whom they’d hand over enough cash to cover bets that go bad. If AIG had imploded, it would have stiffed the companies on the other side of its derivatives bets, who might in turn have stiffed the companies they’d bet with, in an ever-expanding chain of financial destruction. The hope is that clearing will prevent problems at a future AIG from spreading this way, so that the government doesn’t have to intervene.

For the last several months, the big banks, who make billions of dollars trading derivatives, have tried to arrange it so that these proposals would apply to as few transactions as possible. Their efforts have been somewhat successful—the financial reform bill that passed the House in December featured a reasonably broad exemption to the new regulations (though the industry still has its share of gripes). But the language Dodd moved through his Banking Committee last month is significantly tougher, and the administration has expressed its support.

And, yet, when you talk to industry representatives, they don’t appear overly troubled by the recent turn of events. Most continue to regard the derivatives provision in Dodd’s bill as a placeholder, which will almost certainly be nudged aside by a compromise negotiated by Democrat Blanche Lincoln and Republican Saxby Chambliss. (The two senators run the Agriculture Committee, which shares jurisdiction over derivatives.) As one lawyer involved in the derivatives industry told me last week, “If they try to push the Dodd bill as currently written on derivatives—it can’t fly.”

What explains the serene confidence? “Derivatives is the tail on this dog,” the lawyer continued. “It’s not what’s going to drive the bill through Congress. Nor is it the filibuster point. Other stuff makes a lot more noise.” The bottom line, this person concluded, is that voters just aren’t very invested in the details of derivatives reform, and so it’s hard to believe the Democrats will be, too: “Words on the page are not that critical to the public. … The public just wants to see something done here. … To some extent, passing a bill [whatever the details] will be marketed as a success.”


Put this proposition to administration officials, however, and they do some bristling of their own. One official told me it was a case of Wall Street talking its own book: “They want to say it’s inevitable that things will be weaker” so as to make this outcome more likely. The flaw in the banks’ logic, this official explained, is that the importance of once- obscure issues like derivatives actually can be brought home in concrete terms. “I think it’ll be very straightforward to represent the choices to the American people: Keep going with the system that brought you the collapse of AIG and contributed mightily to the financial crisis,” or pass a tough-minded reform package.

And, in fact, not everyone on Wall Street is so convinced of the public’s indifference here. One industry lobbyist recently confided to me that, “Derivatives is so complicated that people don’t understand it, it’s tougher to message on that. But they do understand when you talk about something being totally unregulated.”

As it happens, we may soon have a chance to test this. The staff of Senate Majority Whip Dick Durbin recently met with a variety of pro-reform groups and, according to multiple sources, encouraged them to expand their focus beyond the consumer agency to include such issues as derivatives. The progressive groups are “readying themselves to make a big battle,” says Michael Greenberger, a University of Maryland law professor and former federal regulator with strong ties to the reformers. “Derivatives will be a key part of it. … A lot of these groups are concerned that the consumer agency not suck all the oxygen out of the air.”

Then there are some idiosyncratic developments that could further bolster the hawks. Greenberger notes that Greece used derivatives to hide government debt, a factor that has exacerbated its current fiscal crisis. “The Greek situation brought home to people in the administration … that you can’t have these things being used to create financial havoc,” he says.

Or take Congressman Barney Frank, who chairs the House Financial Services Committee, making him Dodd’s counterpart in the lower chamber. Up until recently, the feeling on Wall Street was that Frank didn’t have particularly strong views on derivatives. But Frank has been outspoken on the issue of late, saying he regretted that the derivatives portion of the House bill wasn’t tougher. Last week he acknowledged that an aide had left to work for a derivatives clearinghouse only weeks after the House passed its financial reform bill in December, a possible wake-up call on the issue. A financial services committee staffer disputes the link between the two developments, noting that Frank both voted against and argued against weakening the derivatives measure in the House. Whatever the case, it’s probably worth heeding the staffer’s warning that, “[t]o think we could be so easily bought off by the consumer piece of this … is a vast underestimation.” (Frank will be a party to any final negotiation.)

In the end, though, the most reliable guide to what’s likely to happen is discerning who has leverage. And, even once you strip away all the rhetoric and the personal narratives, it’s clearly the Democrats who have it. The outcome the industry fears most is that Democrats pass a tough bill on an overwhelmingly partisan vote, isolating Republicans as reflexive defenders of Wall Street. “Everyone in the industry, their line is very simple,” says another administration official. “They want a bipartisan bill.”

According to this same official, the administration doesn’t expect to have trouble finding one or two Republican senators to break a filibuster, even for a hawkish bill. “Frankly there’s a category of [Republican] who is fed up with the party on the issue. They’ve told me so privately,” the official says. “They don’t want to be caught on wrong side of it.” Which means Democrats have the ability to force Wall Street to move their way—not just on the consumer agency, but across the board. The only question is whether they use it.

Noam Scheiber is a senior editor of The New Republic.