Senate Majority Leader Harry Reid and Banking Committee Chairman Chris Dodd were all smiles after the Senate passed its financial reform bill on Thursday. (epa/ZUMApress.com)

This afternoon, the U.S. Senate passed a sweeping financial regulatory reform bill, overhauling the regulation of everything from the biggest banks to consumer financial products to exotic instruments like credit-default swaps to the derivatives used by farmers. The bill passed 60 to 39.

[Congress1] Earlier on Thursday, Republicans Olympia Snowe (Maine), Susan Collins (Maine) and Scott Brown (Mass.) voted for cloture to end debate and move on to the final majority-rules vote. The bill just made the cloture mark, with 60 votes. Sen. Russ Feingold (D-Wis.) chose not to vote with his party, saying he did not find the bill strong enough. White House spokesman Robert Gibbs that President Obama will probably sign the legislation into law next week.

Thus ends a yearlong saga for the bill, whose architects Rep. Barney Frank (D-Mass.) and Sen. Chris Dodd (D-Conn.) spent hundreds of hours in negotiations before coming up with the final package. Work on writing the bills started last summer in the House and the Senate. The House approved its version of reform in December, and the Senate passed its version in May.

The biggest sticking point for reform in the Senate — and one of the reasons the bill took longer than in the House — concerned derivatives, which allow an investor to hedge against price fluctuations in a stock, commodity or other product. The derivatives portion of the bill fell under the purview of the Senate Agriculture Committee, headed by Sen. Blanche Lincoln (D-Ark.). Facing a tough primary challenge from the left, Lincoln inserted a strong provision forcing banks to spin off their trading desks for swaps — a kind of derivative — and to capitalize them separately. Companies vehemently fought against the proposal, but it ultimately appeared, albeit in a slightly changed form, in the final bill.

Once the House and Senate had their bills, the two moved to a conference committee to iron out their differences. In conference committee, the Senate bill was used as the base text, while Dodd led a team of more than 40 legislators voting on various changes. Dodd, Frank and the other conferees addressed everything from regulating derivatives to limiting banks’ ability to bet their own money alongside their clients’. Conference committee culminated in a 20-hour marathon session in June. The combined bill then passed the House again — and today it cleared its last hurdle in the Senate, sending it to the president’s desk.

The final bill, more than 2,300 pages in length, directs regulators to create 533 rules, according to the Chamber of Commerce. The bill contains three central provisions. First, it provides the government with new powers to identify risky banking institutions and to shutter them before they harm the broader financial system, via a new systemic regulator. Henry Paulson, the Treasury Secretary under President Bush when the financial crisis first hit, lauded the provision this week. “We would have loved to have something like this for Lehman Brothers. There’s no doubt about it,” he told The New York Times, referring to the investment bank that collapsed, destabilizing the country’s financial system and contributing to the credit crunch. Democrats say this provision ends “too big to fail,” by providing the government with a way of shutting down failing banks, reassuring counterparties and containing any sense of panic.

Second, the Dodd-Frank bill makes banks less dangerous, forcing them to keep more capital on hand, banning them from making risky trades on their own behalf and keeping them from investing heavily in vehicles like hedge funds. “[The bill] places some limits on the size of banks and the kinds of risks that banking institutions can take,” President Obama told an audience of Wall Street workers this spring, speaking at Cooper Union in Manhattan. “This will not only safeguard our system against crises, this will also make our system stronger and more competitive by instilling confidence here at home and across the globe. Markets depend on that confidence. By enacting these reforms, we’ll help ensure that our financial system — and our economy — continues to be the envy of the world.”

Finally, it creates a new consumer financial protection bureau, which will have the power to create and enforce new rules regarding financial products like home-equity loans and credit cards. “Consumers finally will have a cop on the beat … that will monitor the market and write and enforce the rules,” said Susan Weinstock, the financial reform campaign director for the Consumer Federation of America. “The Wild West for financial products and services is coming to an end. Consumers will now have a bureau that will clear out the tricks and traps in financial products and services that have harmed so many Americans.”

That said, the bill is imperfect by anyone’s measure. It orders 68 studies, and leaves major decisions up to regulators prone to lobbying and industry influence. It includes loopholes, including the glaring exemption of auto dealers who make car loans. But a broad range of experts on Wall Street, consumer protection and governance have lauded it as the strongest reform made since the Great Depression.

“This isn’t just about dollars and cents,” Sen. Harry Reid (D-Nev.), the majority leader, said on the floor. “It’s about fairness and justice. It’s about making sure there’s not a next time. It’s about jobs. And it’s about rescuing our economy.”

Correction: Sen. Scott Brown was initially incorrectly listed as being from Maine. Thanks to commenter Flitedocnm for pointing out that Maine cannot in fact have three sitting senators.

In his prepared testimony, Paulson cites governmental homeownership policy as the underlying reason for the housing bubble and ensuing credit crunch:

Underlying the crisis was the housing bubble, and it is clear that several policy decisions shaped the home mortgage market. Excesses in that market eventually led to a significant decline in home prices and a surge of loan defaults which caused tremendous losses in the financial system, triggered a contraction of credit, and put many Americans — quite literally — out on the street. These excesses were driven in large part by housing policy. From 1994 to 2006, home ownership soared from an already spectacular 64 percent of U.S. households to a staggering 69 percent due to the combined weight of a number of government policies and programs. Fannie Mae and Freddie Mac, the government sponsored enterprises (GSEs) comprised a central part of U.S. housing policy. The GSEs operated under an inherently flawed model of private profit backed by public support, which encouraged risky revenue seeking and ultimately led to significant taxpayer losses.

The United States has always encouraged home ownership, and rightly so. Home ownership builds wealth, stabilizes neighborhoods, creates jobs, and promotes economic growth. But it must be pursued responsibly. The right person must be matched to the right house (and consequently the right home loan), and in the years before the crisis we lost that discipline. The overstimulation of the housing market caused by government policy was exacerbated by other problems in that market.

Geithner, in his prepared remarks, instead focuses on regulation:

Nearly eight decades ago, after a series of banking crises led to the Great Depression, the United States put in place broad protections over the financial system. These reforms — deposit insurance, prudential rules to limit risk-taking by banks, and improved transparency and investor protection in our securities markets — alongside the Federal Reserve’s role as lender of last resort, laid the foundation for a more stable banking industry for several decades.

Over time, however, the financial system outgrew those protections. A large parallel financial system emerged outside of the framework of protections established for traditional banks. A great diversity of financial institutions emerged to provide banking services to individuals and companies, and they were allowed to operate without being subject to the same constraints applied to traditional banks. The shift in mortgage lending away from banks, the growth of the relative importance of non bank financial institutions, the increase in the size of investment banks, and the emergence of a range of specialized financing vehicles are all manifestations of this phenomenon.

Of the two, I think Paulson’s are the more interesting comments. Realistically, I fear there is only so much that the government can do in regulatory terms to stop Wall Street from blowing bubbles in the pursuit of profit — in that Washington can do nothing to shut down Wall Street’s trillion-dollar motive to seek outsize returns. But the Hill can turn off the tap of money and credit at the source of those outsize returns. Rising homeownership combined with and stoked by cheap credit not only put millions of people in homes, but created millions of new funding and securitization streams for Wall Street. If getting rid of Fannie and Freddie removes the government subsidy to that pipeline, in a way, housing market reform could be a bigger deal for the banks than the Dodd bill.

Participants at the meeting were impressed by Obama’s strong command of the issues at hand and appalled by McCain’s acknowledgment that he had not even read Paulson’s three-page bailout plan.

A Republican sitting some distance down the long table whispered to a pair of Democratic senators, “Everyone here is ready to vote for Obama, including the Republicans.” [Democratic House Financial Services Committee Chairman] Barney Frank was even more disgusted than usual. “This was about as unpresidential as it gets,” he said later.

Bush’s expressive face said it all. When Obama spoke, he paid careful attention, as if he knew that here was his successor. When McCain spoke, Bush’s face was quizzical and unconvinced, as if he’d eaten something sour.

But that was the civilized portion of the meeting. Shortly thereafter, Paulson begged Democrats not to attack the bailout plan. But it was the Republicans who had withdrawn their support, and Frank was incensed at Paulson’s suggestion that Democrats were somehow to blame.

Barney Frank muscled his way past Harry Reid and started yelling. “F— you, Hank! F— you! Blow up this deal? We didn’t blow up this deal! Your guys blew up the deal! You better tell [GOP Rep. Spencer] Bacchus and the rest of them to get their s— together!” When Paulson tried to equivocate, Frank threw in another “F— you, Hank!” — his third of the day.

For all the bedlam at the meeting, Obama and his team emerged confident that the election was theirs to win — and that the country needed them to win.

“That was surreal,” Obama said on the speakerphone from the car on the short ride back to the hotel, with several campaign aides on the call. “Guys, what I just saw in there made me realize, we have got to win. It was crazy in there.”

“Maybe I shouldn’t be president,” he said in his familiar wry tone, only with more amazement than usual. “But he definitely shouldn’t be.”

Yesterday, the Wall Street Journal reported that BofA chief executive Ken Lewis told New York’s attorney general in February that Federal Reserve Chairman Ben Bernanke and then-Treasury Secretary Henry Paulson told Lewis to keep mum about Merrill’s steep losses at the end of 2008, as well as $4 billion in bonuses Merrill intended to pay employees, lest the news spook BofA shareholders and kill the acquisition deal.

Geithner, of course, was neck deep in crafting the bailout strategies under the Bush administration, and now Towns, who heads the House Oversight and Government Reform Committee, has joined forces with Rep. Dennis Kucinich (D-Ohio), who chairs the Domestic Policy subpanel, to ask what role Geithner played in the controversial BofA-Merrill deal.

From the lawmakers’ April 23 letter to Geithner:

If Mr. Lewis’s statement, as reported by the Journal, of discussions that occurred between Mr. Paulson, Mr. Bernanke and himself is accurate, then federal officials were potentially involved in knowingly denying BOA investors material information.

The lawmakers are asking Geithner for “all documents prepared for internal use related to discussions with Bank of America and/or Treasury about compensation packages, bonuses, annual losses at Merrill Lynch, and federal guarantees against losses on Merrill Lynch assets, for the period August I, 2008 through January 19,2009,” as well as “discussions relating to public disclosure of information about compensation packages, bonuses, and annual losses at Merrill Lynch.”

A similar version of the letter went to Bernanke. And unlike the first inquiry over executive compensation limits — which Geithner still hasn’t responded to, even eight days after the requested deadline –  Towns and Kucinich are threatening to subpoena the officials for the information if they don’t get it otherwise.

The implications of Mr. Lewis’ testimony, if accurate, are extremely serious. Under these circumstances failure to comply with the Subcommittee’s request raises the prospect that we will be forced to consider compulsory means to achieve compliance with our request. However, we would prefer your voluntary compliance.

Guess the Obama honeymoon is officially over.

We pointed out a few reasons earlier today why Dodd doesn’t bear the blame (at least no more or less than most others in this town). Yet it’s worth going back even further to understand where the laxity originated that permitted enormous paydays for the same folks who ruined their companies.

Start the clock in September, when Henry Paulson, treasury secretary under the Bush White House, was charged with selling Congress on the $700 billion Troubled Asset Relief Program. As part of his pitch, Paulson, along with Federal Reserve Chairman Ben Bernanke, repeatedly insisted that executive compensation limits should be avoided, lest they hobble the effectiveness of the program.

“If we design it so it’s punitive and so institutions aren’t going to participate,” Paulson told Fox News at the time, “this won’t work the way we need it to work.”

Congressional leaders (including Dodd) caved, adding only a few loophole-filled provisions restricting executive pay, including language that the Treasury “shall require that the financial institution meet appropriate standards for executive compensation.”

Fast forward to December, when Neel Kashkari, appointed by the Bush administration to administer TARP, appeared before the House Financial Services Committee, where he was asked point blank by Rep. Brad Sherman (D-Calif.) whether enormous AIG bonuses — some reportedly as high as $3 million — were indeed “appropriate” considering that the flailing insurance giant had already received $152 billion in federal help. The exchange is eye-opening:

SHERMAN: Sir, have you met your responsibility to require that appropriate standards of executive compensation be imposed on AIG and the other recipients of TARP funds?

KASHKARI: This is an important issue that we must not lump all of the institutions together.

SHERMAN: I’m not.  I’m asking about A-I-G.  Is a three million dollar bonus an appropriate standard of executive compensation, or has the law been violated?

KASHKARI: Congressman, I can’t… I do not have the details of what the bonus levels are at AIG.

SHERMAN: Well, you are the one who is supposed to impose appropriate levels of executive compensation.  Have you done that?  Or, are they making payments of executive compensation that are not appropriate? Or are you just blind to whether they are appropriate or not?

KASHKARI: Congressman, we have imposed on AIG new corporate governance standards, executive compensation standards and expense policy standards…

SHERMAN: Do your standards prevent the payment of a three million dollar bonus?

KASHKARI: I do not believe that they specifically prevent a payment of a three million dollar bonus.

SHERMAN: So have you imposed appropriate standards for appropriate executive compensation?  Are you here to tell this committee that appropriate standards of executive compensation would allow a three million dollar bonus?  How about a 30 million dollar bonus?  Would that be appropriate compensation?  Or would that be prohibited by any standards that met the statutory requirement imposed on Treasury?

KASHKARI: Congressman, in the case of AIG, we replaced with the Federal Reserve the senior management of AIG.

SHERMAN: Sir, I didn’t ask you about corporate governance.  I didn’t ask you about the make-up of the executives.  I asked whether a three million dollar bonus, or a 30 million dollar bonus, is consistent with a statutory requirement that we have appropriate standards on executive compensation.  Let me ask it specifically.  As to 30 million dollars, is that appropriate or inappropriate?  Or you have no opinion?

KASHKARI: I am not in the position to opine on a specific number if it is appropriate or not.

In light of all the recorded statements and testimonies, the GOP’s Dodd-centered criticisms should be easy to shoot down. Then again, no one ever claimed that accuracy was more important than messaging in this town.

And, of course, Kashkari is still in charge of TARP.

Aside from the comedy surrounding that development (the Bush administration’s original refusal to help the automakers was the only reason that Congress took up legislation to begin with), there’s now concern that the administration will manage Washington’s latest bailout attempt as poorly as it did the last. House Speaker Nancy Pelosi (D-Cal.) shot a letter to President Bush last week urging the White House to insist on certain conditions and concessions from the companies in return for the help:

The Administration must now require, as a condition of receiving those taxpayer funds, the same tough accountability and shared sacrifice by all parties –- executives, unions, suppliers, creditors, dealers, bondholders, and shareholders –- mandated in the bipartisan legislation passed by the House this week.

The New York Times reports this morning that the details of the deal are still being worked out, but Treasury Sec. Henry M. Paulson Jr. will take on the oversight responsibilities. GM has said it needs $10 billion to get it through March, while Chrysler would need $4 billion to survive the same stretch.

On CNBC earlier this week, Paulson said “failure by these companies at this time is not something any of us want to contemplate.”

There was no word how any of the bailout’s terms will address the larger reality that Amercans aren’t buying cars now from anyone.

In a Dec. 3 letter to Treasury Sec. Henry M. Paulson Jr. and Federal Reserve Chairman Ben Bernanke, the Republicans questioned the changing nature of the now-misnamed Troubled Assets Relief Program, or TARP.

Changing conditions can require agility in policymakers’ responses. However, the seemingly ad hoc implementation of TARP has led many to wonder if uncertainty is being added to markets at precisely the time when they are desperately seeking a sense of direction.

[...]

The government has burned through nearly $350 billion of TARP funds and is pledging trillions of dollars more through other programs, yet little is understood about how these investments are contributing to the nation’s economic recovery.

Sounding like Democrats, the GOP leaders also asked for more transparency, blasting Paulson for his slow response to questions from House Minority Leader John Boehner (R-Ohio) sent before Halloween.

More than a month ago, on October 29, the House Republican Leader sent a letter to the Treasury Secretary questioning the use of TARP money for executive bonuses and bank acquisitions by other banks, as revealed by various news organizations. It was only today that Treasury provided a response, and the response did not answer the questions that were asked in the Leader’s letter.

White House spokeswoman Dana Perino was incredulous today at the thought that the administration has a history of being unresponsive to Congress. Perhaps today’s letter will trigger an epiphany.

Mr. Geithner also oversaw and regulated an entire industry whose decline has delivered a further blow to an already weakened American economy. Under his watch, some of the biggest institutions that were the responsibility of the New York Fed — Bear Stearns, Lehman Brothers, Merrill Lynch and most recently, Citigroup — faltered. While he was one of the first regulators to smartly articulate the potential for an impending disaster, a number of observers question whether he went far enough to stop the calamity.

Sorkin also questions how effective Geithner has been in helping Treasury Sec. Henry M. Paulson Jr. manage the administration’s bailout strategy. Some observers have fingered Geithner as a proponent of the controversial decision to let Lehman Bros. fail:

Perhaps what has most people on Wall Street stirring is Mr. Geithner’s role in the fall of Lehman. At the time of its bankruptcy, he, along with Mr. Paulson, appeared to be the most vocal in supporting the government’s refusal to bail out the firm, according to people involved in various meetings. With hindsight, many in the financial industry blame a deepening of the global financial crisis on the government’s decision to let Lehman crumble.

That, Sorkin suggests, has led the Obama folks to try to rewrite the history books on the Lehman deliberations in order to let Paulson absorb all the blame:

These include the suggestion that Mr. Geithner was not in league with Mr. Paulson over Lehman; that Mr. Geithner pressed to save the firm from bankruptcy; that he was a lone voice on the subject and was overruled by Mr. Paulson and Ben S. Bernanke, the Fed chairman, on this issue.

In the confidence game of high finance, maybe none of this matters, and the reaction of Wall Street investors alone is enough to justify Geithner’s promotion. Still, you’d like to know that the guy at the helm of the Treasury Dept. knows which direction to steer.

…underlines the contrast between the administration’s activity in this area and its failure to take similarly decisive action to reduce mortgage foreclosures. As I told Secretary Paulson when he informed me this morning of his decision to provide funds for Citigroup, I believe it is essential that TARP funds be used immediately to fund mortgage foreclosure relief… There is no good reason for further delay.

Sounds like the honeymoon for these two finance wizards might be reaching its end.

Bring on the finance regulations.

That’s the message this week from a growing number of Democratic leaders, who are increasingly irritated by the reluctance of the financial industry to put capital it received from the Bush administration’s $700-billion bailout to work.

Lenders not lending. Executives keeping large pay packages. Banks distributing dividends to shareholders. The reports have been numerous. This is not, according to Sen. Chris Dodd (D-Conn.), chairman of the Senate Banking Committee, the way the program was supposed to work.

“Let me say as clearly as I can: hoarding capital and acquiring healthy banks are not — I repeat, are not — reasons why Congress authorized $700 billion in emergency funding,” Dodd told finance industry representatives during a Thursday hearing on bailout oversight.

Illustration by: Matt Mahurin

Dodd called on the industry to step up its efforts to stem foreclosures, accelerate lending and rein in executive pay. “And if that progress is not forthcoming,” he added, “we are prepared to legislate — now if possible, but next year if necessary.”

Like many Democrats, Dodd seemed surprised that banks and other financial institutions would be driven by profit motives. So Democratic leaders share part of the blame. After all, they caved in to administration pressures and included only minimal restrictions on how the bailout money would be spent.

The debate is at least partly ideological. The administration and many congressional Republicans oppose more industry regulations, arguing that free markets work best when governments stay out of the way. But in the middle of an economic whirlwind caused largely by poor investment decisions by banks and other financial firms, that argument has lost some steam.

“What we’ve learned over the last number of months is that consumer protection and economic growth go hand-in-hand,” the Connecticut senator said. “In fact, when you fail to do the first, you end up doing severe damage to the latter.”

Dodd’s comments come a day after Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, largely echoed Dodd. Charging that mortgage servicers have been too quick to refuse loan modifications, Frank said legislation is likely needed to encourage them.

The two Democrats’ remarks arrive as the struggling financial industry — the recipient of billions of dollars in federal help in recent months — has been slow to use the money as Congress intended.

Instead of increasing lending to thaw out frozen credit markets, for example, some banks have bought other banks. Instead of using the capital infusion to modify home mortgages and prevent foreclosures, many lenders continue to pay out dividends. In some cases, banks participating in the bailout program have given large bonuses to some employees.

Sen. Tim Johnson (D-S.D.) called for “punitive actions” if bailout funds are “misused.” Dividends and large pay packages, Johnson added, “should be rewards for a job well done — and that is currently not the case for many in this industry.”

Appearing before the Senate panel Thursday, representatives for some of the nation’s largest banks — including Bank of America, Wells Fargo and JP Morgan Chase — vowed not to use bailout funds for executive pay. But they defended the continuation of dividend payments, contending that those funds come from a pool of “retained earnings,” not the “capital-base” pool recently supplemented by the bailout. Also, they said, that practice will not likely change.

“We would anticipate that dividends will continue to be paid out of our earnings stream and not out of our capital base,” said Barry L. Zubrow, chief risk officer at JP Morgan Chase.

Dodd said he is “a little nervous about this distinction because … money is money.”

Under the $700-billion ressue package, passed in a din of controversy last month, the Treasury Dept. has the power to use the cash on virtually anything it deems necessary to stabilize the flailing economy.

Originally, the plan called for the Treasury to buy up toxic mortgage-backed securities and residential loans on the books of banks and other financial institutions. Treasury Sec. Henry M. Paulson Jr., however, switched gears. The government used $250 billion to recapitalize the firms in exchange for equity stakes in them. Another $40 billion went to prop up insurer American International Group.

The strategy changed again yesterday, when Paulson announced that the remainder of the bailout funds would be used to bolster consumer credit markets. But the administration must first get congressional approval, and that gives Democratic congressional leaders some leverage to alter the program, though they would have to pass new legislation to do so.

There is some indication that they will press for more transparency on how the Treasury is using the bailout money. Rep. Charlie Rangel (D-N.Y.), chairman of the House Ways and Means Committee, said Thursday that the department has abused its authority in implementing the bailout. “We think they’re going beyond the discretion given to them,” Rangel said during an interview with CNN. “We are going to really legislate, if they don’t come clean with this.”

Speaking of greater transparency, Sen. Charles Grassley (R-Iowa) on Thursday announced plans to reintroduce legislation to rein in another largely unregulated sector of the financial system: hedge funds. The bill would require hedge funds to register with the Securities and Exchange Commission. Currently, the funds are exempt from SEC oversight.

Democrats might also push the administration to do more to slow the rate of foreclosures, which triggered the financial crisis. Many experts say the larger economic crisis cannot be fixed without first stabilizing the housing market — and that means curbing foreclosures. Dodd said that it’s “still confounding” why Paulson hasn’t tackled the problem directly.

Meanwhile, the economy continues to tank. In the first week of November, the number of first-time applicants for unemployment insurance jumped to 516,000 — a seven-year high — the Labor Dept. reported Thursday.

The dismal figures may have emboldened Democratic leaders to press the administration to accept economic-stimulus legislation this month aimed at boosting consumer spending.

“Americans losing their jobs every day cannot wait for the next administration to take action,” House Majority Leader Steny Hoyer (D-Md.) said in a statement Thursday.

Central to the plan is new spending on state infrastructure projects like bridges and roads and bailing out Detroit’s automakers — proposals the White House has resisted. In what will likely be the final squabble between the Democratic Congress and outgoing President George W. Bush, lawmakers are expected to return to Washington next week to consider the bill.

Lining up behind the administration, many congressional Republicans have fought these spending programs, as well as new regulations for the finance industry. They question the logic of attaching more restrictions on companies already down. “I think we should be very careful in moving in a direction where we’re going to mandate that mortgage companies have certain behavior,” Rep. Randy Neugebauer (R-Tex.) said this week.

Dodd, however, rejected the idea that government oversight strangles private enterprise.

“I think we need to get over that notion … that if you’re going to protect consumers, it’s going to hurt our economy,” he said. “I think we’ve learned painfully how false that statement is.”