As the battle over health care reform comes to a close, the question of financial reform is once again pushed into the spotlight.  Though the Obama Administration, the Democratic majority in both houses of Congress, and leading financial institutions on Wall Street all recognize the need for reform and some regulation, the current ultra-partisan political climate will make successful reform difficult.  Financial institutions, such as Goldman Sachs and Morgan Stanley, support regulation but fear that the use of financial reform as a political weapon will hurt performance, whereas the members of the Senate and House of Representatives has shown an inability to effectively compromise on controversial elements of legislation.

Somewhat surprisingly, key Wall Street executives have recently come out in favor of pushing forward with financial reform, largely in an effort to restore the industry’s credibility in the eyes of an angry public.  Ben White of Politico makes the crucial point that any regulatory reform bill would likely lead to a small reduction in earnings in some sectors, but that any decline in revenue would generally be offset a subsequent restoration of public confidence.    Wall Street executives are also eager to get out off of the front page and out of the public eye, something that can only be achieved once financial reform is passed or killed in Congress.  It should be noted, however, that Wall Street executives remain opposed to several key facets of the Democratic Party’s reform package; unpopular elements include a proposed $90 billion tax on the country’s largest financial institutions, a proposed Consumer Protection Agency and the ‘Volcker Rule’.

Substantial differences exist in vision for and structure of the proposed consumer protection institution in the House and Senate versions of financial reform legislation.  The House version, passed with 223 votes on December 11, 2009, creates a single, free-standing Consumer Financial Protection Agency, with an independent director appointed by the president.  If the House plan is adopted, the Consumer Financial Protection Agency would receive broad powers to write and enforce rules on banks, credit unions, and other financial companies, but would not be responsible for oversight of certain other types of business, such as retailers and auto dealers.  The Senate version of financial reform legislation houses a Consumer Financial Protection Bureau within the Federal Reserve, again with an independent director appointed by the president.  The Senate would also allow provide this bureau with broad powers to write rules, but would limit its enforcement reach to banks and credit unions with assets of $10 billion or more and other large financial organizations.

In addition to sharp differences between Senate and House bills, certain proposed measures have effectively divided the country’s representatives on party lines.  A provision to allow minority shareholders to nominate their own candidates to a company’s Board of Directors, championed by Senator Chuck Schumer (D – NY), is one such measure.  Introduced by Senator Chris Dodd (D – CT) and approved by the Senate Banking Committee on a 13-10 party-line vote, this measure would ease the expense required to place dissident candidates on the ballot side-by-side with those candidates preferred by the company.  This proposed measure is deeply unpopular throughout the Republican Party, despite the influence of Senators Schumer and Dodd, will likely prove a sticking point in the larger process of financial reform.

We have already begun to see elements of compromise within the Democratic position.  The aforementioned bill, for example, calls for a Securities and Exchange Commission investigation and report into whether or not brokers should be held to the same fiduciary standards as registered investment advisor.  Instead of attempting to establish firm legal guidelines on the nature of the modern broker – principal relationship, Dodd and the Democratic Party have suggested an investigation that will likely be lost in irrelevance, concluding long after the financial reform debate is over and the issue has left the public eye.  This early de facto concession is likely the result of the tough road ahead and is indicative of the desire of Wall Street to pass a reform bill without any more teeth than is absolutely necessary.  Similar concerns surround proposed derivative reform; the current bill calls for them to be traded on exchanges, but too many exceptions already exist for derivatives reform to be effective.

While all sides agree that financial reform generally is necessary, both to restore public confidence in Wall Street and to soften or prevent future recessions, substantial disagreement exists over the proper mechanisms of reform.  Given the extremely partisan climate of Washington, compromise will likely be nearly impossible.  As in the case of health care reform legislation, certain conservative Democrats will wield disproportionate swing votes at every stage of negotiation.  Ultimately, Wall Street’s desire to end their post-recession public relations nightmare will force the passage of financial reform legislation.  The contents of that final piece legislation, however, remain to be seen.