[Guest post by Noam Scheiber:]

As of Thursday morning, I gave the House and Senate negotiators little chance of reaching a financial-reform deal in time for the president’s appearance at the G-20 meeting in Toronto this weekend. They’d spent the previous week working at a relatively leisurely pace—bankers’ hours, you could call them—and, characteristically, left the toughest issues for last. Well, egg on my face. After a punishing 20-plus-hour session that evoked shades of a Wimbledon match that won’t end, the conferees reached agreement earlier this morning.

At the broadest level, my feelings about this deal, at least what I know of it so far, are roughly in line with how I felt about the bill the Senate produced last month: All things equal, I’d like to have seen the country’s biggest financial institutions broken up in order to solve various moral hazard and systemic risk problems. But, given the political realities, that probably wasn’t in the cards. And the bill does address bigness in other ways. Taken together, the various new regulations significantly raise the costs of running a big financial institution, not just in absolute terms but relative to small institutions. That’s a good thing in and of itself—which is to say, independent of the specific rationale for each regulation—because it creates incentives for the biggest banks to shrink over time.

From this perspective, the understanding the conference committee reached yesterday turned out slightly better than I expected, and I thought it was shaping up to be pretty solid already. The bill preserves the regulations that hit big banks harder than small ones—things like higher capital requirements and more intrusive consumer regulation—but adds new burdens, like a $19 billion fee on the biggest banks engaged in the riskiest activities. (This is to cover what CBO determined to be the 10-year cost of implementing the new regulations.)

The rest of the last-minute compromises are a mixed bag. The negotiators did largely adopt the tougher Volcker-Rule language championed by Senators Carl Levin and Jeff Merkley—that is, the rule that would prevent banks from placing risky bets for their own bottom line. (The concern is that banks do this using taxpayer-backed funds.) The previous version of the rule, passed in the Senate, could have enabled future regulators to ignore it entirely. The only catch is that, in order to nail down the support of Senator Scott Brown, the final bill allows big banks to invest up to 3 percent of their own capital in hedge funds and private equity funds. That's a bit tough to swallow since, as one Senate aide reminded me a few weeks ago, Bear Stearns only owned a tiny fraction of the hedge funds it bailed out to the tune of several billion dollars when their subprime investments went bad. True, the compromise has a clause that prevents the parent bank from undertaking such bailouts going forward, but I have no idea how tight that will be in practice.

The other big last-minute deal involved a proposal by Senate Blanche Lincoln to force the big derivatives dealers (basically a handful of the biggest banks in the country) to disgorge their derivatives operations and place them in a separate subsidiary, one that would have enough capital to absorb potential losses and which the banks wouldn’t be allowed to bail out. (A derivative is a bet on the prices of another asset, like a stock or a bond, or on the movement of some other variable, like interest rates or foreign exchange.) In principle, this proposal shouldn’t have aroused much opposition, since the banks are going to have raise new capital to support their derivatives operations regardless of where they house them. But, in practice, the banks’ seemed to be think that they could get away with less capital if their derivatives desks stayed put, or that their implicit backing would give them an advantage over smaller rivals when making derivatives deals. 

Whatever the case, the banks went nuts over the proposal. The compromise is to let the banks hang on to what have been dubbed less risky derivatives, like those involving interest rates and foreign exchange, while forcing riskier bets into a Lincoln-style subsidiary. My queasiness here is that it’s not clear you can know in advance which derivatives are riskiest, and it’s obviously too late once they cause a meltdown. (The whole problem with AIG’s derivatives portfolio, which led to the company’s collapse, is that it was assumed to be almost riskless. Then one day it wasn’t…). But from the vantage point of marginally increasing costs on large institutions, I consider this another step in the right direction.

Overall, there are still a number of key details that remain unclear—either because I can’t tell exactly where the conferees came down in the end, or because the final decisions have been kicked to regulators. In the first category, I don’t yet know where we ended up on exempting derivatives from what’s known as clearing—that is, submitting them to a middleman, to which both sides of the bet have to post collateral. (The middleman would then step in to make one side of the bet whole if the other collapses, a la AIG.) Banks want to avoid this for as many derivatives transactions as possible because it’s costly. And while the loophole is definitely narrower than it looked like it would be last fall, we’ll just have to wait and read the fine print to find out how much narrower.

Meanwhile, in terms of the capital banks will need to cushion themselves against future losses, much of that is yet to be determined by regulators, largely in consultation with financial officials from other countries as they hammer out new international agreements. So a good chunk of the financial reform process is really just beginning. The one twist in terms of capital is that the conferees largely prohibited big banks from counting a certain type of financial instrument as capital even though it a looks a lot more like debt to the naked eye (and, therefore, isn't very useful for shoring up a balance sheet). In addition to being a good idea in itself, it’s yet another example of imposing new costs on big banks relative to small ones—the big banks tend to rely more heavily on this trick, and banks with less than $15 billion in assets are altogether exempted—so it’s yet another disincentive for banks to become enormous.

A final, macro thought on where we go from here: Many hands have been wrung (including my own at times) about the fact that financial bureaucrats will have so much influence over the shape of the legislation. Even if you trust Team Obama (as I do), you have to worry about their possible successors under a GOP administration bent on waging anti-regulatory jihad. In fact, you don’t even need to imagine that to be anxious. History shows that even otherwise sober-minded officials are just as susceptible to bubble psychology as the rest of us.

But if there are ways that financial regulation is likely to weaken over time, there are other ways that it’s likely to strengthen. For example, the Democratic leadership was finally forced to exempt auto dealers from the new consumer regulatory agency late last night—Barney Frank, the lead House negotiator, conceded that they just didn’t have the votes to do otherwise. But that hardly strikes me as the final word on regulating auto loans. To the contrary, now that we’ve taken the big step of creating a consumer agency, it strikes me as relatively easy to expand its purview. And I’m guessing that the next time we hear about a sympathetic military family getting screwed by a deceptive auto loan, that’s what’s going to happen. So this bill really is just the beginning in more ways than one.