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Complete study, then crack down

WASHINGTON, D.C. — What to do about the size of too-big-to-fail banks? Order a study. How to hold stockbrokers accountable for their dealings with clients? Another study. How to ensure the reliability of credit rating agencies? Study that, too.

Time after time as Congress wrestled with contentious decisions on how to re-regulate the nation’s financial industry, it opted for what often is the classic Washington punt: further study. In all, the 2,300-page overhaul of financial regulations requires more than 60 such studies, on everything from examining the presence of shoddy Chinese drywall in foreclosed houses to judging the financial literacy of U.S. consumers.

“Studies can often be used as a way to delay, and can be a way for the money of the biggest banks to still have influence and undermine real accountability,” said Heather Booth, campaign director for a coalition of labor and consumer activists called Americans for Financial Reform.

“They can also be used to provide thoughtful guidance for action,” she added, “and it can be used to reinforce the hand of regulators who want to rein in reckless activity.”

The legislation, expected to face a final vote in the Senate next week, still represents a massive overhaul of financial regulations. The abundance of studies does not reflect the totality of the bill, but it illustrates the reliance the legislation places on regulators to meet the ambitious goal of preventing a recurrence of the 2008 financial crisis.

As negotiators assembled the legislation, they came up with compromises that eased the bite of stronger measures, put off action on new rules or gave regulators a greater say on what restrictions to adopt and how to make them work. Some examples:

  • A study of how banks hire firms to rate the risk of their investment products, a substitute for actually upending the way rating agencies are retained;
  • A study of whether secured creditors should be forced to absorb losses when the firms they invest in are liquidated. The House would have mandated 20 percent losses, but studying the issue first was deemed more prudent.

Many of the studies are simply information-gathering exercises to help determine the need for new policies, such as an instruction to Congress’ investigative arm, the Government Accountability Office, to look into the number of Securities and Exchange Commission employees who leave to work for firms regulated by the agency.

But several studies were designed as the middle ground when tougher measures proved politically unpalatable, such as requiring a proposed new oversight council of regulators to study if the government should set strict limits on the size of banks, rather than actually imposing them. A Senate proposal that would have required the nation’s six biggest banks to slim down to a fraction of their size had failed by a nearly 2-to-1 vote.

And while some studies just kick the can down the road, the bill often demands eventual regulatory action.

For example, the House wanted the SEC to impose the same professional standards on stockbrokers and dealers that are imposed on financial advisers. The Senate bill called for a study but left the SEC with no authority to then implement the results. The House-Senate compromise specifically gives the SEC power to issue rules governing brokers, with the instruction to apply the results of the study.

Likewise, lawmakers tried to address the reliance investors place on credit rating agencies. Their rosy ratings of mortgage-backed securities helped precipitate the 2008 financial crisis. And because the rating agencies were paid by the firms issuing the financial products, their very independence came into question.

The Senate, through a proposal offered by Sen. Al Franken, D-Minn., sought to avoid the potential for conflicts of interest by having an independent board assign rating agencies to financial firms. But during House-Senate negotiations, House Democrats proposed striking Franken’s proposal and offered a study instead.

Senate Democrats countered creatively, accepting the study but insisting that after two years the SEC would have to adopt the method proposed by Franken unless regulators come up with a better system.

“One of the things we tried to assure is that the studies would lead to appropriate action,” said Sen. Jack Reed, D-R.I., one of the Senate negotiators. “We’ve put in place the architecture for improved performance of the financial system; some of the detail work will have to be on the regulators.”

Douglas Elliott, former investment banker at J.P. Morgan and a fellow at the Brookings Institution, said the studies are a subset of Congress’ general approach of deferring much of the details of the legislation to regulators. That means many of the remedies that would address past failures are still a year or two away — time for the industry to continue to influence the rules they live by.

“Fairly sensibly, given the complexity of the financial sector, Congress didn’t try to nail down everything,” Elliott said. “We’re essentially halfway done once this legislation passes. The other half will be decided by the regulators, and there will be an immense level of lobbying.”

Edward Mills, a financial policy analyst at FBR Capital Markets, said that in leaving studies and decisions to the agencies that oversee the industry, Congress is giving regulators flexibility to react to new financial schemes and products.

“When it comes to financial services, legislation is a blunt instrument,” he said. “If you just have (prescribed regulations) in the text of the legislation rather than giving a framework and leaving it to the regulators to implement, you run the risk of financial institutions being creative.”

The trust the legislation places on the regulators is a double-edged sword. Regulatory agencies were blamed for not seeing the crisis coming and for being more attentive to the industry’s financial growth than to the needs of consumers. But regulators are more wary now, analysts say, and might not be as susceptible to political pressures as members of Congress.

“It’s not always the case that leaving it to the regulators makes it easier for the industry to win,” Elliott said.