WASHINGTON — As the Senate takes up sweeping bank reform after the financial system's near collapse in 2008, a battle is brewing on Capitol Hill over whether legislators should limit the amount of borrowed money that the biggest and most important firms use.
Republicans and Democrats in the Senate are sparring over a provision approved as part of a mammoth House bank-reform bill that would cap the big firms' borrowing, called leverage, at a 15-to-1 ratio.
The rationale behind such a move is to keep big banks from growing dangerously large so that if they fail, they won't cause collateral damage to the markets.
The Obama administration doesn't back the House plan, and it doesn't have a companion sponsor in the Senate, which will likely begin considering a broad bank-reform bill in late January or early February.
The current Senate bank bill would leave it to a newly formed consolidated bank regulator, made up of other financial agencies, to identify what leverage limits are appropriate.
Sens. Mark Warner, D-Va., and Bob Corker, R-Tenn., two Senate Banking Committee members charged with reaching a bipartisan deal on systemic risk issues, aren't working on setting a statutory limit on leverage, according to people familiar with their efforts.
Nevertheless, it's possible a leverage limit — popular among consumer groups — could become one part of a much bigger package of "too-big-to-fail" reforms expected to include a mechanism — with funding — to dismantle a failing big bank so that its collapse doesn't ripple through the markets.
"High leverage has been shown to have been one of the best predictors of major financial firms falling into distress or needing government support during the current crisis," said Rep. Jackie Speier, D-Calif., the provision's sponsor.
"I believe that it is a mistake to leave all discretion in how to accomplish that task to the primary regulators," she said. "Regulators had the power to avert much of the current crisis, but they bought in to the collective myopia and failed to exercise that power."
Backers of the bill privately worry about whether it will survive the process of reconciling the Senate and House versions of bank reform, which isn't expected to come to pass until the spring.
Nevertheless, critics of the leverage limit argue that "boots-on-the-ground" bank regulators are in a better position to identify how much leverage and risk a particular financial institution can handle.
"We prefer Congress not set the leverage limits because one size does not fit all. We think the regulators, who are boots-on-the-ground, should continue to set limits," said Scott Talbott, senior vice president at the Financial Services Roundtable in Washington. "Regulators need the flexibility to adjust based on different companies they regulate."
Some worry an across-the-board leverage cap for big banks would have the effect of discouraging lending to consumers and businesses—ironically, just as lawmakers, the White House and public press the institutions to offer more loans.
"The House is putting the horse ahead of the cart here; leverage limits should be set up by the regulator," said Nancy Bush, managing member of NAB Research in Annandale, N.J.
Alternatively, another approach is gaining traction on Capitol Hill, but not yet with any member of the banking committee.
Sens. John McCain, R-Ariz., and Maria Cantwell, D-Wash., on Dec. 16 introduced legislation that could break up the big institutions by prohibiting retail banks with depositors from engaging in investment-banking activities, such as underwriting securities.
If it were to become law, it could force J.P. Morgan Chase to divide into two companies, and Bank of America's acquisition of investment bank Merrill Lynch could be unwound. The bill has four Democratic co-sponsors.