And today, as the Dodd-Frank bill passed the Senate and moved on to the president’s desk, he said as much in a strongly worded 2,000-word speech. He notes that he supports the bill, and voted for it, and believes it to be “the best bill that could pass” given the effective 60-vote requirement in the Senate. But, he described reform as a “missed opportunity.”

The entire letter is below, but I will summarize the two main critiques. First, Kaufman worries that the bill gives far too much authority to regulators — regulators who are far too often cozy with the subjects they monitor, and unwilling to go after companies during good times. He notes that Congress could have written strict codes into the bill, as he recommended. But it did not, meaning that the bill might not be successful in stymieing unsafe business practices.

That being said, unfortunately, I believe the bill suffers from two major problems.  First, the bill delegates too much authority to the regulators. I’ve been around the Senate for 37 years.  As I said on the Senate floor on February 4th of this year and in several speeches since then, I know that many times laws are not written with hard and clear lines. Laws are a product of legislative compromise, which often means they are vague and ambiguous.  We often justify our vagueness by saying the regulators to whom we grant statutory authority are in a better position than we are to write the rules — and then to apply those regulatory rules on a case-by-case basis.  But, as I have said, this was not one of those times.

Second, Kaufman argues that the bill does not do enough to end “too big to fail.” It does not reinstate Glass-Steagall, which barred Wall Street investment banks from purchasing depository Main Street banks. It does not do enough to isolate risk out of big, important institutions.

[T]he legislation does not go far enough in addressing the fundamental problem of “too big to fail.” Instead of erecting enduring statutory walls as we did in the 1930s, the bill invests the same regulators who failed to prevent the financial crisis with additional discretion and relies upon a resolution regime to successfully unwind complex and interconnected mega-banks engaged across the globe. I am also disappointed that key reform provisions like the Volcker Rule and the Lincoln swaps dealers spin-off provision were scaled back in conference.

Only time will tell whether Kaufman’s contentions are correct, of course. But for him to release such an impassioned letter on the day reform passed has to sting for more progressive members of the Democratic team that produced Dodd-Frank. Full letter below.

Mr. President, after months of careful consideration, landmark financial reform legislation moves towards final passage.  While this bill is a vast improvement over the existing regulatory structure, I believe it should go further with respect to erecting statutory walls that address the fundamental problem of “too big to fail.” I will support the conference report, though I do so with significant reservations about a missed opportunity to enact needed structural reforms that would better prevent another financial crisis.

Ultimately, given the make-up of the Senate and the requirement of 60 votes, this was the best bill that could pass. For those who wish the bill was stronger, let there be no confusion about where the blame lies.  It is because almost every Senator on the other side of the aisle did everything they could to stall, delay and oppose Wall Street reform.

To be sure, the bill that has come out of conference includes some extremely important reforms.  It establishes an independent Consumer Financial Protection Bureau (CFPB) with strong and autonomous rulemaking authority and the ability to enforce those rules for large banks and nonbanking entities like payday lenders and mortgage finance companies. In addition, it requires electronic trading and centralized clearing of standardized over-the-counter derivatives contracts as well as more robust collateral and margin requirements.  The bill’s inclusion of the Kanjorski provision will give regulators the explicit authority to break up megabanks that pose a “grave threat” to financial stability.  And I was pleased that the bill includes a provision I helped develop to give regulators enhanced tools and powers to pursue financial fraud.

Through the Collins provision, the bill also establishes minimum leverage and risk-based capital requirements for bank holding companies and systemically risky non-bank institutions that are at least as stringent as those that apply to insured depository institutions.  In light of the failures of past international capital accords, this requirement will set a much-needed floor on how low capital can drop in the upcoming Basel III negotiations on capital requirements. It will also ensure that the capital base of megabanks is not adulterated with debt that masquerades as equity capital.

That being said, unfortunately, I believe the bill suffers from two major problems.  First, the bill delegates too much authority to the regulators.  I’ve been around the Senate for 37 years.  As I said on the Senate floor on February 4th of this year and in several speeches since then, I know that many times laws are not written with hard and clear lines. Laws are a product of legislative compromise, which often means they are vague and ambiguous.  We often justify our vagueness by saying the regulators to whom we grant statutory authority are in a better position than we are to write the rules – and then to apply those regulatory rules on a case-by-case basis.  But, as I have said, this was not one of those times. This was a time for Congress to draw hard lines that get directly at the structural problems that afflict Wall Street and our largest banks.

Despite repeated urging from me and others to pass laws that would help regulators to succeed, Congress largely has decided instead to punt decisions to the regulators, saddling them with a mountain of rulemakings and studies.  The law firm Davis Polk has estimated that the SEC alone must undertake close to 100 rulemakings and more than a dozen studies.  Indeed, Congress has so choked the agencies with rulemakings and studies, the totality of the burden threatens to undermine the very ability of the agencies to accomplish their ongoing everyday mission.  I for one urge the agencies to triage carefully these required rulemakings and studies, establish a hierarchy of priorities, and ensure that the agencies do not shift all resources to new rules meant to address old problems to such a degree that they fail to stay on top of current and growing problems.  I will have more to say on this subject in a future speech.

Second, the legislation does not go far enough in addressing the fundamental problem of “too big to fail.” Instead of erecting enduring statutory walls as we did in the 1930s, the bill invests the same regulators who failed to prevent the financial crisis with additional discretion and relies upon a resolution regime to successfully unwind complex and interconnected mega-banks engaged across the globe. I am also disappointed that key reform provisions like the Volcker Rule and the Lincoln swaps dealers spin-off provision were scaled back in conference.

The bill mainly places its faith and trust in regulatory discretion and on international agreements on bank capital requirements and supervision.  After decades of deregulation and industry self-regulation, it is incumbent upon the regulators now to reassert themselves and establish rulemaking and supervisory frameworks that not only correct their glaring mistakes of the past, but also anticipate future problems, particularly risks to financial stability.  Unfortunately, the early indications we are seeing out of the G-20 and so-called Basel III discussions are not encouraging, as critical reforms are already being watered down and pushed back in part because some foreign regulators carelessly refuse to heed the risks posed by their megabanks.

The legislation also puts in place a resolution authority to deal with these institutions when they inevitably get into trouble.  While such authority is absolutely necessary, it is not sufficient.  That is because no matter how well Congress crafts a resolution mechanism, there can never be an orderly wind-down of a $2-trillion financial institution that has hundreds of billions of dollars of off-balance-sheet assets, relies heavily on wholesale funding, and has more than a toehold in over 100 countries.  Of course, since financial crises are macro events that will undoubtedly affect multiple megabanks simultaneously, resolution of these institutions will be enormously expensive.  And until there is international agreement on resolution authority, it is probably unworkable.

Given the history of financial regulatory failures and the enormous burden of rulemakings and studies with which the regulators are being tasked, Congress has a critical oversight responsibility.   Congress first must ensure that the regulators have enough staff and resources at their disposal to follow through on their serious obligations.  Just as important, Congress must monitor the regulatory phase of this bill’s implementation closely to ensure that the regulators don’t return to “business as usual” when the experience of the most recent financial crisis fades into memory.

Volcker Rule

For example, in addition to granting great discretion to regulators on how they interpret the ban on proprietary trading at banks, the scaled-back Volcker Rule contains a large loophole that allows megabanks to continue to own, control and manage hedge funds and private equity funds under certain conditions.  Most notably, it includes a de minimis exception that permits banks to invest up to three percent of Tier 1 capital in hedge funds and private equity funds so long as their investments don’t constitute more than three percent ownership in the individual funds.

The impact of a supposedly small three percent de minimis exception for investments in hedge funds and private equity firms has the potential to be massive.  For example, a $2 trillion bank that has $100 billion in Tier 1 capital would be able to invest $3 billion into hedge funds.   Since that $3 billion could only constitute three percent ownership, it would need to be invested alongside at least $97 billion of funds from outside investors.   The bank would therefore be able to manage $100 billion in hedge fund assets, a massive amount equal to the current size of the largest hedge funds in the world combined.   What’s more, that $100 billion in assets can be leveraged several times over through the use of borrowed funds and derivatives into overall exposures that could exceed a trillion dollars.  And given the ambiguity of the legislative language, unless clarified by a rulemaking, some commentators have indicated that megabanks could potentially provide prime brokerage loans to hedge funds they partially own and run.

Fortunately, the final bill does place costs on banks’ de minimis investments in hedge funds and private equity funds.  Specifically, the legislation requires a 100% capital charge on these proprietary investments, making them expensive for banks to hold.  While this may be a helpful deterrent, I am concerned that it will not be enough of one, particularly when considering how lucrative and risky an activity it is for banks to run hedge funds and private equity funds.

The overarching problem is that banks will continue to be able to offer and run – never mind, partially own – risky investment funds.  Even though the scaled-back Volcker Rule includes a “no bailout” provision, I have concerns about the credibility of that edict.  Under any circumstance, the failure of a massive hedge fund run by a megabank would pose serious reputational and financial risks to that institution.

Just look at what happened when the structured investment vehicles (or SIVs) of Citigroup and other megabanks began to falter.  Because of the reputational consequences of liquidating these funds and allowing them to default on their funding obligations, they were bailed out by the megabanks that spawned them even though the SIVs themselves were generally separate, off-balance-sheet entities with no official backing from the banks.

Finally, the strength of the core part of the Volcker Rule – the ban on proprietary trading – will depend greatly on the interpretation of the regulators.  They will ultimately be the arbiter of whether broad statutory exceptions for “market making” or “risk-mitigating hedging” or “purchases” or “sales” of securities on “behalf of customers” are allowed to swallow the putative prohibition.  I therefore urge the regulators to construe narrowly those activities that constitute exceptions to proprietary trading to ensure that the Volcker Rule has some teeth in it.

Swaps Dealer Spin-Off

Senator Lincoln’s original swap dealer spin-off provision would have prohibited banks with swap dealers from receiving emergency assistance from the Federal Reserve or FDIC.  By essentially forcing megabanks to spin off their swap dealers into an affiliate or separate company, this section would have helped restore the wall between the government-guaranteed part of the financial system and those financial entities that remain free to take on greater risk.  It would also have forced derivatives dealers to be adequately capitalized.

While the final bill includes the Lincoln provision, it limits its application to derivatives that reference assets that are permissible for banks to hold and invest in under the National Bank Act.  Since that exception covers interest rate, foreign exchange and other swaps, it ultimately exempts close to 90% of the over-the-counter derivatives market.   Regulators must therefore reduce counterparty exposures by requiring the vast majority of derivatives contracts to be cleared and calibrate carefully the amount of capital that bank derivative dealers must maintain.  Only then can we be sure we never again face a meltdown caused by excessively leveraged derivatives exposure that no regulator helps to keep in check.

Conclusion

The financial reform bill places enormous responsibilities and discretion into the hands of the regulators.  Its ultimate success or failure will depend on the actions and follow-through of these regulators for many years to come.  It is estimated that various federal agencies will be charged with writing over 200 rulemakings and dozens of studies.  Many of the same regulators who failed in the run-up to the last crisis will once again be given the solemn task of safeguarding our financial stability.  Like many others, I am concerned whether they have the capacity and wherewithal to succeed in this endeavor.

I repeat again, Congress has an important role to play in overseeing the enormous regulatory process that will ensue following the bill’s enactment.  The American people, for that matter, must stay focused on these issues, if just to help ensure that Congress indeed will fulfill its oversight duty and its duty to intervene if the regulators fail.  Likewise, although I will be leaving the Senate in November, I will be watching closely to see how the regulators follow through on the enormous responsibilities they are being handed.

Let us not forget why reform is so necessary and important.  After years of Wall Street malfeasance and the systematic dismantling of our regulatory structure, our financial system went into cardiac arrest and our economy nearly fell into the abyss.   Wall Street, which had grown out of control on leverage and financial gimmickry, blew up.  More than 8 million jobs were wiped out; millions more have lost their homes.  We spent trillions of dollars in monetary easing and emergency measures to avert the wholesale failure of many of our megabanks.  Not surprisingly, we continue to feel the aftershocks of the worst financial crisis since the Great Depression.  The banks are not lending.  Fed Chairman Bernanke just days ago urged them to do more for small businesses.  Companies and consumers alike remain shaken in their confidence.  And despite dramatic stimulus measures, the economic recovery has been slow and tentative.

Many of the opponents of Wall Street reform would like to make the dubious claim that the recovery is being held back by uncertainty about future regulations and taxes. In reality, it is being held back by the financial shock and the fact that we are still in a period of financial instability and undergoing an excruciating process of deleveraging. Even now it is unclear whether a European banking crisis based on their holdings of sovereign debt will continue to impede that recovery.  It is therefore imperative that we build a financial system on a firmer foundation.

The American economy cannot succeed unless we restore and maintain financial stability.  We simply cannot afford another financial crisis or continued financial instability if the American economy is to succeed in the coming decades.  Getting financial regulation right and maintaining it for years to come should be one of this nation’s highest priorities because the price of failure is far too high.

Gen. David Petraeus testifies before the Senate Armed Services Committee on Wednesday. (Pete Marovich/ZUMApress.com)

At a Senate Armed Services Committee hearing Wednesday on strategy for the war in Afghanistan, a discussion of the Obama administration’s approach to securing the southern Afghan city of Kandahar — a crucial test for the escalated war — was overshadowed by a partisan dispute over the meaning of the administration’s July 2011 “inflection point” for transferring security responsibilities to Afghan forces.

[Security1] Gen. David Petraeus, commander of U.S. forces in the Middle East and South Asia, and Michele Flournoy, the undersecretary of defense for policy, two architects of the administration’s counterinsurgency strategy in Afghanistan, told incredulous Republican senators on the committee that the rate of troop reductions after July 2011 will be “determined by conditions” on the ground, a formulation repeated by Petraeus at least five times during the three-hour hearing. Both Petraeus and Flournoy expressed confidence that the Afghan government understands the American desire for a “long-term relationship” with Afghanistan long after the United States withdraws the bulk of its troops, providing specific commitments to Afghan security, governance and economic development over the “next five to ten years,” as Flournoy put it.

But several Republicans on the panel expressed dismay that the administration set a date to begin security transfers, and argued that establishing it created confusion in the region over the United States’ commitment to waging the war, including within Afghan President Hamid Karzai’s government. Sen. John McCain (R-Ariz.) said it was unwise for the administration to leave the impression, in the reported words of White House Press Secretary Robert Gibbs, that the date is “etched in stone,” since McCain said Afghan government officials have told him the date makes them doubt the administration’s resolve.

Yet Petraeus affirmed that “July 2011 is etched in stone.” Prompted by a question from Sen. Ted Kaufman (D-Del.), he reiterated that “July 2011 is the point at which, again, the term ‘responsible drawdown’ of the surge forces begins at a rate to be determined by the conditions” on the ground. The date itself won’t prompt the U.S. to “race for the exist,” Petraeus said, pointing to Obama’s West Point declaration that success in Afghanistan is a “vital national security interest,” a phraseology that Petraeus said signaled steadfastness to the military.

That still didn’t satisfy several Republicans. Late in the hearing, Sen. Lindsey Graham (R-S.C.) walked out of the room after declaring himself “confused” by the date and the officials’ explanation of it. “I doubt that the enemy is certain,” he said, leaving before Flournoy could respond to his point.

Addressing a different aspect of the meaning of July 2011, both Petraeus and Flournoy said it was “not the intention” or “expectation” to send any additional troops to Afghanistan after the date passes. But Petraeus said he considered it part of his “responsibility to the troopers” not to explicitly rule out recommending reinforcements should circumstances warrant. He said that “despite the losses, despite the setbacks,” the trajectory of the war effort was “upward,” describing counterinsurgency campaigns as a “roller coaster” instead of a glide path, a point echoed by Flournoy. Petraeus pointed to an affirmation Gen. Stanley McChrystal, the commander of the war, made to the committee after Obama’s most recent 30,000-troop increase that sufficient forces existed in Afghanistan to break the Taliban’s momentum by July 2011, and Petraeus expressed confidence that the mission would succeed.

Faith in the strategy, Petraeus added, came from the performance of President Hamid Karzai. He and Flournoy rejected a New York Times account last week, based heavily on a cashiered member of Karzai’s government, that Karzai had lost confidence in U.S. will to fight the Taliban. They pointed to remarks Karzai made on Sunday to a Kandahar shura that pledged support for the ongoing “rising tide of security” in the city and earned popular affirmation for impending military operations. But that was as deeply as senators probed the two senior officials on the war and governance strategy for what McChrystal has described as a crucial operation.

Apparently seeing a political opportunity, Sen. Carl Levin (D-Mich.), a reluctant supporter of Obama’s tripling of troop levels in Afghanistan, quickly distributed a printed statement to reporters at the hearing that highlighted Petraeus’s unwillingness to break with the administration over the impending troop reductions that will follow July 2011. “I am glad to hear Gen. Petraeus express his support for the decision to begin troop reductions in Afghanistan in July 2011,” it read. “I strongly believe it is essential for success in Afghanistan that everyone understand the urgency with which the Afghans need to take responsibility for their own security.”

The hearing Wednesday was a continuation of a Tuesday session in which Petraeus took ill, briefly losing consciousness from what he described as dehydration.

The point is this: The arguments against shrinking the largest financial institutions are found wanting. And sufficient or not, ending the existence of TBTF institutions is certainly a necessary part of any regulatory reform effort that could succeed in creating a stable financial system. It is the most sound response of all. The dangers posed by institutions deemed TBTF far exceed any purported benefits. Their existence creates incentives that will eventually undermine financial stability. If we are to neutralize the problem, we must force these institutions to reduce their size.

I do not want to be naïve here. I am not suggesting that our banking system devolve into institutions like the Bailey Building and Loan Association in It’s a Wonderful Life. Large institutions have their virtues. They can offer an array of financial products and services that George Bailey could not. A globalized, interconnected marketplace needs large financial institutions. What it does not need, in my view, are a few gargantuan institutions capable of bringing down the very system they claim to serve.

Fisher described the bill’s reliance on regulators — foremost, the Federal Reserve, where he is a major figure — as dangerous. The House and Senate bills give regulators the power to shut down systemically important and overly risky firms. But Fisher doubts whether, in a climate of financial insecurity, regulators would really do so:

The sad truth is that when the chips are down, regulators become reluctant to put their money where their mouths are — or more precisely, they become too eager to put their money where they said they would not. Few, if any, policymakers have been willing to let large banking organizations fail, thereby missing an opportunity to impose significant losses on failed institutions’ creditors. We know from intuition and experience that any financial institution deemed TBTF will not be allowed to fail in the traditional sense. When such an institution becomes troubled, its creditors are protected in the name of market stability. The TBTF problem is exacerbated if the central bank and regulators view wiping out big bank shareholders as too disruptive, extending this measure of protection to ordinary equity holders.

The Treasury Department and figures on the Hill argue that the other prudential measures in the bill — capital and leverage requirements, and the Volcker Rule splitting commercial and investment banking functions, for instance — would prevent too-big-to-fail banks from becoming risky in the first place. But Fisher seems to support the Safe Banking Act, which would have put hard caps on the size of banks. The provision, by Sens. Sherrod Brown (D-Ohio) and Ted Kaufman (D-Del.), did not make it into the final Senate bill.

But the Senate did vote — suddenly — on Sens. Sherrod Brown (D-Ohio) and Ted Kaufman’s (D-Del.) amendment to break up big banks and impose strict capital and leverage requirements. It failed, 33 to 61, with about half of Democrats voting against it. Democratic staffers say that capital and leverage provisions — less controversial than breaking up the bank provisions — might be inserted via other amendments.

And the Senate is done voting for the week.

The two amendments have both received bipartisan support despite strong — if until very recently behind-the-scenes — opposition from the executive branch, including the White House, Treasury Department and Federal Reserve. That opposition had been giving senators pause. For instance, Sen. Claire McCaskill (D-Mo.) had indicated she would vote for the strong audit of the Federal Reserve, but then backtracked. Expect to see more and more senators indicating a firm yes or no today as the vote on the Sanders amendment might come as early as this afternoon.

Sanders, for the past day or two, has punched back against opposition to his amendment, telling ABC News, for instance, that the implication that auditing the Fed will impinge or politicize monetary policymaking is false. “It’s not accurate. I know that’s what the Fed is saying. I know that’s what Treasury is saying. But it’s bogus,” Sanders said. “What people are saying is the Fed has enormous power and while Congress absolutely should not be doing monetary policy — raising interest rates, lowering interest rates — it is unacceptable to give trillions of dollars in zero or near-zero interest loans to large financial organizations, with the American people having no idea which organizations.”

In a statement, the lawmakers cite the reasoning behind the proposal.

Under current law, possession of five grams of crack cocaine (roughly the weight of two sugar cubes) triggers a mandatory minimum five-year prison sentence, while trafficking 500 grams (approximately one pound) of powder cocaine triggers the same sentence. The so-called 100:1 sentencing disparity has been in place since 1986. The Fair Sentencing Act would eliminate the disparity, treating crack and powder cocaine equally.

Sen. Richard Durbin (Ill.), the upper chamber’s second-ranking Democrat, said passage of the bill is long overdue.

The sentencing disparity between crack and powder cocaine has contributed to the imprisonment of African Americans at six times the rate of whites and to the United States’ position as the world’s leader in incarcerations. Congress has talked about addressing this injustice for long enough; it’s time for us to act.

Other sponsors of the bill include Democratic Sens. Patrick Leahy (Vt.), Arlen Specter (Pa.), Chris Dodd (Conn.), John Kerry (Mass.), Al Franken (Minn.), Ted Kaufman (Del.), Russ Feingold (Wis.), Ben Cardin (Md.) and Sheldon Whitehouse (R.I.).

In July, the House Judiciary Committee advanced a similar bill, sponsored by Rep. Robert Scott (D-Va.).

The troop numbers are only one piece of a much larger set of policy adjustments, Levin said, including more trainers, more equipment, and more support for Afghan forces.

“The media has been focusing on [troop numbers] like it’s the public option or something,” said Levin. “It’s going to be a much more comprehensive recommendation.”

The first interpretation is that we shouldn’t focus so much on troop levels. Which is like whhaaaaaa…? Of course everyone’s going to focus on troop levels; it’s a war out there in Afghanistan. It’s appropriate for journalists to spend our time reporting on troop levels — not to the exclusion of everything else, but we, you know, haven’t, I think it’s fair to say.

The other interpretation is that McChrystal’s recommendations on resourcing the war will be, as Levin said, “much more comprehensive” than just U.S. troops. You can probably figure out which interpretation I incline toward.

Delaware’s governor today tapped a long-time adviser to Joe Biden to fill the Senate seat being vacated by the vice president-elect. Ted Kaufman served in Biden’s Senate office from 1973 to 1994, and currently serves on Biden’s vice-presidential transition team. From Biden’s statement:

I have known Ted Kaufman for over 30 years. He is a man of first-rate qualifications, unquestioned integrity and a long-time commitment to public service. As my Chief of Staff for 19 years, he was involved in many of the most important decisions I’ve made in the Senate. Further, he has been personally involved in handling many of the most important issues that we’ve faced in Delaware. From protecting Cape Henlopen, to putting more cops on the street, Ted has played a critical role in these accomplishments.

According to the Wilmington News Journal, however, there may have been other considerations as well. The paper reports that the choice “was widely seen as a move by Vice president-elect Biden to protect his seat for his son, Attorney General Beau Biden, now deploying to Iraq with his Delaware National Guard unit.”

And you know if there was a winner, there had to be a loser:

Snubbed with the choice was Lt. Gov. John Carney, considered a party favorite for the appointment. Carney as recently as last week had said he would take the job under any terms offered, including as a “placeholder” who would serve only until the 2010 regular election.

The News Journal said the pick “could leave Delaware Democratic Party feelings bruised for years to come.”