Obama to Wall Street: financial reform is in your interest

President Obama sought to bridge the divide between very different worlds – Wall Street and the rest of America – as he argued for financial reform legislation in a speech Thursday.

"Ultimately, there is no dividing line between Main Street and Wall Street," the president told a crowd at Cooper Union college in Manhattan that included some of America's richest bankers. "We will rise or we will fall together as one nation.... I urge all of you to join me, to join those who are seeking to pass these common-sense reforms."

Here's how Mr. Obama may be right with that "one nation" argument: The economy needs a financial system, and banks can best succeed as part of a vibrant broader economy.

But where Obama said reform is "in the interest of your industry," that doesn't necessarily mean it will be good for bankers personally. For many, the reforms may mean smaller paychecks and less dealmaking freedom.

For many bankers, the pre-reform world meant huge trading profits and fees from complex derivatives. It meant bonuses that hinged on short- rather than long-term performance. And, when things went badly, that world included massive government bailouts that helped banks get back on their feet.

By contrast, the post-reform world could very well mean lower profits during good times, more regulatory oversight, and tougher consequences for firms that get into trouble. In the view of many proponents, that's what will happen if the reforms work.

Different points of view

In that sense, Wall Street and Main Street view financial reform from different angles.

Obama acknowledged the divide even as he sought to bridge it. "We will not always see eye to eye," he said to bankers, as he lamented what he called the "furious efforts" of industry-funded lobbyists to water down the legislation.

His administration views bank reform as a capstone of its economic recovery plans – designed to make the financial system more stable so that it can support the growth of US businesses. The House has already passed its bill, while the Senate is nearing a vote on legislation brokered by Sen. Christopher Dodd (D) of Connecticut.

In his address Thursday, the president emphasized four key elements of the package:

1) Protecting the economy and taxpayers from fallout when a large financial firm collapses. New "resolution authority" would allow the government to shut down failing firms in a way that's intended to contain the ripple effects while making the industry (not taxpayers) pay any costs.

2) New transparency and oversight of trading in so-called derivative securities.

3) Consumer protections, aiming to prevent deceptive terms and conditions in products such as mortgage loans. He did not talk about a new agency for this purpose, perhaps a sign that this move (opposed by many in the financial industry) is not a go-to-the-mat issue for him.

4) Power for shareholders to have a "say on pay" for executives. Obama added that the Securities and Exchange Commission (SEC) "will have the authority to give shareholders more say in corporate elections."

The bills also seek to redesign the regulatory apparatus that oversees banks, and to ensure that banks hold adequate capital to remain solvent during recessions.

How does Goldman Sachs fit in?

Whether the timing is coincidental or not, the SEC's fraud lawsuit against Goldman Sachs this week has served to highlight the gap between the world of finance and America's everyday economy.

The lawsuit centers on whether a Goldman vice president properly disclosed the terms of a derivatives deal to the investors involved. Vast sums were at stake, all tied to the direction of the US housing market, yet the deal had little if any relevance on Main Street. The so-called "synthetic CDO" was not helping to finance home loans, but enabled one group to bet that certain home loans would lose value, while other investors bet that they wouldn't.

Derivatives have emerged as a central battleground for reform-bill lobbying.

The reforms would require that most derivative securities be cleared in a centralized system, making it easier for the industry and regulators to keep track of risk exposure. Market participants would also face new capital requirements as a backstop in market downturns. Such moves promise to make a huge marketplace safer but also less profitable for Wall Street firms.

Derivatives targeted

If those changes take some icing off the derivatives cake, a move by Sen. Blanche Lincoln (D) of Arkansas this week might take the cake away entirely. She won committee-level support for a measure banning mainstream banks from the derivatives business. Her proposal may not make it into a final package for Obama to sign, but the possibility symbolizes how the reform process threatens current Wall Street ways.

Do ordinary Americans and businesses view Wall Street as an ally or a threat?

The answer is more nuanced than public opinion polls would suggest – polls that show a strong aversion to the bailouts and to high banker bonuses. There's a lot of anger at Wall Street, but also plenty of distrust of Washington and fear that regulation run amok might hurt the economy.

This reflects a debate that, in America, goes back to the days of Jefferson and Hamilton. Obama sought to reassure his listeners that his reform push is about balance, not extreme measures.

"There has always been a tension between the desire to allow markets to function without interference and the absolute necessity of rules to prevent markets from falling out of kilter," he said. "Managing that tension ... is what has allowed our country to keep up with a changing world."