The GOP and the Politics of Financial Reform

April 21, 2010

This is a season of discontent for congressional Democrats. This week's Pew Poll holds plenty of bad news for them. Congress's favorability ratings stand at 25%, the lowest in the poll's nearly three decade-long history. The Pew Poll also found that the more upset independents are about the current state of politics, the more likely they are to throw out the Democrats. The independents that are most upset favor Republicans 66% to 13%.

All of this explains why Democrats hope Sen. Chris Dodd's proposed financial reform legislation will put some distance between them and the Obama administration's reckless spending policies over the past year. They believe that by overhauling the rules Wall Street lives by, they can redirect populist anger away from them and toward the financial sector. But voters are smart enough to see through the ploy.

Republicans made a smart early move by pointing out that Democrats want to enact legislation that would create a $50 billion bailout fund for big Wall Street firms. After being forced to admit the fund is part of the bill, Democrats defended it by saying it would be funded with money from the firms themselves.

Senate Republicans responded by saying that regardless of where the fund got its money, it would give Wall Street a leg up on Main Street. Why? Because the fund would allow government-favored Wall Street firms to borrow money more cheaply than their Main Street competitors.

Goldman Sachs, for example, would likely be able to borrow money at a lower interest rate than a regional bank or credit union. That idea isn't sitting well with voters already upset about the cozy relationship between Big Government and Big Business.

Feeling the heat from the public, Democrats might drop their government-sanctioned rescue fund. But that won't end their troubles.

Democrats are also playing with fire by pushing to create a Consumer Financial Protection Agency. Republicans oppose interfering with or duplicating existing regulatory agencies. Voters might side with the GOP on this one.

Then there's the thorny issue of derivatives, which are complex financial instruments increasingly used by Main Street companies to hedge risk. For example, airlines use derivatives to insulate themselves against swings in jet fuel prices, and manufacturers use them to protect against commodity price increases.

Democrat proposals would restrict many of the derivatives Main Street firms use to remain competitive. That's not a smart approach at a time when voters are already worried about the economy. It also allows Republicans to argue that, in a rush to punish Wall Street, Democrats will end up harming Main Street companies and cost many Americans their jobs.

There are other potential pitfalls for Democrats in Mr. Dodd's bill. One is a provision that would create an Office of Financial Research that would receive half a billion dollars a year to gather information on individual financial transactions so government bureaucrats can analyze the data and suggest policy changes. I suspect Americans don't want a new bureaucracy sweeping their brokerage and bank accounts for information.

Mr. Obama should hope Republicans are successful in convincing Democrats to write a sensible financial regulation bill. After all, if congressional Democrats and the administration enact a bad financial reform bill, they could raise the cost of capital, retard economic growth, and drive wealth out of this country and into foreign financial markets that are more welcoming to derivatives. That, in turn, could hurt the president's re-election chances in 2012.

For Democrats in 2010, economic conditions are already baked in the cake. Incipient growth, high unemployment, lots of disgruntled job seekers, battered family budgets, and intense concern about government spending and deficits have energized voters and convinced many of them that change is needed in Washington. As a result, congressional Democrats will likely suffer bigger loses this year than the post World War II midterm average of 24 seats in the House and four in the Senate.

On the other hand, the economic circumstances of Mr. Obama's re-election are still up in the air. If Democrats get financial regulation right, there's a chance the economy could be strong enough by 2012 to give Mr. Obama a good shot at winning a second term.

But if Democrats get financial regulation wrong and the economy is stumbling come 2012, Americans are not going to reward the man who gifted them four straight anemic years. If that's the case, no amount of whining, spinning or adroit use of teleprompters will save Mr. Obama from voter wrath.

This article originally appeared on on Wednesday, April 21, 2010.

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