The U.S. Senate has begun debate on a bill to overhaul America's financial system in what would be the most far-reaching reform since the Great Depression of the 1930s. The effort comes two years after a devastating financial crisis that continues to weigh on the U.S. economy. The 2008 crisis focused attention on Wall Street's appetite for speculative deal-making that can yield enormous profits in boom times, but can threaten the nation with financial collapse when markets go bad.
Most Americans are familiar with basic financial terminology like stocks and bonds. But until recently, few had ever heard of Wall Street's more arcane financial instruments like derivatives or synthetic collateralized debt obligations. These inventions of modern finance are part of the system that funds and insures corporate ventures, or places bets on those ventures' success or failure.
Wall Street's complex dealings were on display during a Senate hearing earlier this week, ahead of Senate debate on financial reform.
Current and former executives of investment giant Goldman Sachs faced intense questioning over the firm's marketing of products tied to a risky segment of America's home mortgage industry. Senators wanted to know how, in good conscience, Goldman Sachs could sell those products without informing clients that the firm was investing in other instruments that would pay off, if the mortage backed securities failed.
Chief Executive Officer Lloyd Blankfein:
"In the context of market-making, that is not a conflict," said Blankfein.
Goldman Sachs executives said they were product creators and vendors - not investment advisors to their clients.
Their answers did not satisfy Democratic Senator Carl Levin of Michigan, who spoke on ABC television's Good Morning America program.
"They [Goldman Sachs] have to disclose to the pension fund or whomever they are selling to that they think the instrument is not a good investment," said Senator Levin. "They should be telling folks, 'We are betting against this instrument. We are taking bets against what we are selling to you.'"
The failure of mortgage-related products led to the collapse of many of America's biggest financial institutions, prompted massive government bailouts of the private sector and triggered a credit squeeze that battered an already-faltering U.S. economy. But by placing bets against those products, Goldman Sachs made money, while the nation plunged into recession.
Senator Levin says the firm's actions exemplify why Wall Street must be reformed.
"This [capitalist] market of ours is not free of self-dealing or conflict of interest," he said. "It is not free of gambling debts that taxpayers end up paying."
The Democrat-sponsored financial reform bill seeks to boost consumer protections in the financial industry, strengthen regulation and oversight of financial firms, limit the risk-taking ability of banks and other institutions, and establish a procedure for the federal government to liquidate financial firms that become insolvent.
A key concept promoted by the bill's sponsors is transparency - that Wall Street players should be more forthright about the investments they make and the deals they strike.
But analysts point out that financial firms expend great energy and resources to craft investment strategies which, if revealed to the public, could be rendered ineffective or be copied by competitors.
Mark Williams teaches finance at Boston University and spoke on Bloomberg Television:
"More disclosure should give better information to market participants," said Mark Williams. "Where it could hurt Goldman Sachs and other market makers is if they have a proprietary book and they are taking positions and making large bets. That [disclosure] is like opening up their trade book to the marketplace. That reduces their profitability."
Other analysts question whether Washington is capable of crafting a law that weeds out Wall Street's most destructive behavior without destroying the underpinnings of America's capitalist system.
Former U.S. Comptroller of the Currency Eugene Ludwig points to derivatives - contracts whose price is derived from the price of the underlying financial asset - that have been much-maligned in the aftermath of the financial crisis.
"If you ask most people, they would say, 'Oh my God, they [derivatives] are bad things," said Eugene Ludwig. "I just saw it on television!' Yes, derivatives, like lending money to the mob [i.e., organized crime] is a bad thing. It does not mean we prohibit loans. Derivatives can be used well or they can be used poorly."
Republicans and Democrats differ on several key points of financial reform - including the scope of government intervention in the economy and consumer protection, and what should be done to limit taxpayers from paying for future bailouts.
Republicans agreed late Wednesday to end their procedural maneuver that blocked Senate debate of the bill, citing important concessions from Democrats. But Republicans still could hold up a final vote on the legislation.