BIG PICTURE: Oil Spill Has Taken Focus Off Financial Overhaul

15th Jun 2010 12:35

(This article was originally published Monday.) By Kathleen Madigan A DOW JONES NEWSWIRES COLUMN NEW YORK (Dow Jones)--BP executives have replaced Wall Street traders as the most vilified businessmen. As a result, the federal legislation to overhaul the financial system, currently working its way through the reconciliation process in Congress, has taken a back seat. That's a concern, because fixing the financial system, making it stronger and less prone to blow-ups, is one of the pillars needed to ensure a healthy economic recovery in the U.S. Senate and House lawmakers are expected to agree on an overhaul package by the end of June, but an agreement might have come earlier had the ongoing oil spill not begun weeks ago. It might have been a stronger accord, too. With the administration focused on dealing with the oil spill, less time and energy is likely spent on ensuring that the compromises necessary to settle the legislation are the best available. On Monday came news that House negotiators want to shield ratings agencies, whose failures to rigorously test complex securities are widely seen as a key cause of the credit crunch, from private lawsuits to a greater degree than the Senate version allows. Another proposal, still up in the air, would permanently raise the limit of deposit insurance to $250,000 and offer greater protection for noninterest-bearing transaction accounts, protection that some say encourages both customers and banks to indulge in riskier behavior as they don't have to bear the consequences. The delay in getting the overhaul resolved is also hurting the broad economy. Until the new rules are known, uncertainty hangs over the financial markets and banks will remain hesitant to lend. "Legislative uncertainties, particularly on regulatory reform, certainly have held back lenders," says Milton Ezrati, senior economist at Lord Abbett. "It is hard, for instance, for bank managers to justify an aggressive expansion in lending when a new law aimed at limiting the size of financial institutions might require them subsequently to shrink their asset base." Deleveraging in the private sector has been a key curb on economic growth. Household debt has fallen for six straight quarters. Some of the decline has been the result of defaults, especially on mortgages, but households have also reduced their credit-card use and banks have raised lending standards for personal loans. Consumers now have to rely on income, not credit, to support increased spending. That shift, coming during slow job growth, is keeping consumer purchases rising at a modest pace. The business sector is also feeling the stinginess of banks. Michael Moran, chief economist at Daiwa Capital Markets, says banks' tight lending restrictions have had a bigger impact on small- and medium-sized firms than larger corporations that can access the bond market. Looking at Fed data, Moran points out noncorporate business--mainly smaller firms--haven't raised external funds since late 2008. Without increased funding, these companies--which create the bulk of new jobs in the U.S.--can't expand their facilities or add workers. As if the lack of urgency isn't enough, politics also complicates the legislation's fate. Sen. Blanche Lincoln (D., Nebraska) faced down a primary challenge in part by playing up her proposal to stop banks from derivatives trading. A possibility exists that other politicians facing tough midterm elections could add on other proposals that do more to win votes than to solve the problems of avoiding another financial wipeout. Federal Reserve Chairman Ben Bernanke warned Congress last week about such unintended consequences. "You have to be careful that you don't inadvertently, for example, prevent good hedging, which actually reduces risk; or that you don't prevent market making, which is good for liquidity," he said. Unless Congress takes the time and focuses on creating a well-crafted package, a financial overhaul could worsen the next crisis it is intended to prevent. (Kathleen Madigan, a special writer, is the primary author of the Big Picture column. She covered the economy for over two decades at BusinessWeek and Wall Street firms. She can be reached on +1 212 416 2466 or via email at: [email protected].) (TALK BACK: We invite readers to send us comments on this or other financial news topics. Please email us at [email protected]. Readers should include their full names, work or home addresses and telephone numbers for verification purposes. We reserve the right to edit and publish your comments along with your name; we reserve the right not to publish reader comments.) (END) Dow Jones Newswires June 15, 2010 07:35 ET (11:35 GMT)