What's missing from Wall Street reform

WASHINGTON (CNNMoney.com) -- Senators are expected to start voting Wednesday on changes to a Wall Street reform bill that has been more than a year in the making.

But even with all that time and effort, there are some key areas considered critical to the financial crisis that have been left out -- either because they're too complicated, politically controversial or transitional to be dealt with this go-round.

The financial overhaul bills in the Senate, and one that already passed the House in December, don't:

-- Stop banks from growing "too big."

-- Address the framework that created incentives for credit rating agencies to rubber-stamp risky financial products.

-- Take on the troubled government-backed mortgage backers Fannie Mae and Freddie Mac.

Senators from both parties plan to bring up amendments to resolve omissions in coming weeks. However, changes will require a filibuster-proof 60 votes to get tacked on, a pretty high threshold.

Here are the three things that aren't the bills, as of now:

Nothing in the Wall Street reform bills would prevent mega banks from remaining big or even getting bigger.

While both the House and Senate bills would beef up powers that regulators already have to shrink banks if they endanger the financial system, critics such as economist Simon Johnson believe regulators don't have the best track record in exercising such powers.

Laws currently prevent U.S. banks from holding more than a 10% share of deposits. But there are ways around the rules. For example, banks can grow past that level through if they do so "organically," through new accounts.

Three banks - Bank of America (BAC, Fortune 500), Wells Fargo (WFC, Fortune 500) and JPMorgan Chase (JPM, Fortune 500) - each have more than 10% of the nation's deposits, about $750 billion, according to Senate records.

Two senators believe that's way too big, whether they're in trouble or not.

Sen. Ted Kaufman, D-Del., and Sen. Sherrod Brown, D-Ohio, want Congress, not regulators, to set hard caps and leverage limits - no exceptions. In addition to enforcing a hard 10% cap on deposits, they would also cap nondeposit bank liabilities at 2% of U.S. gross domestic profit.

Banks that are over the caps would have to sell or divest, which the senators acknowledge would hit the nine largest banks particularly hard.

"We're only asking Citigroup to go back to where it was in 2003," Kaufman said Tuesday. "Was Citi competing in 2003? I think they were."

But groups representing the banks say that the amendment relies on flawed logic. They say healthy big banks aren't the problem.

"The problem of 'too big to fail' isn't that some banks are large, it's that we don't have the legal authority or procedural framework to seize and take down a large (failing) bank," said John Dearie, executive vice president for policy at the Financial Services Forum, a trade group for large financial firms.

The bills fail to address problems with credit rating agencies, which are firms paid by an issuer to grade the risk of a financial product.

These agencies have drawn increased scrutiny for approving mortgage-related securities, such as the kind Goldman Sachs sold to investors without disclosing a hedge fund was betting against them.

Lawmakers from both parties recognize the inherent conflicts of interest with credit rating agencies that get paid from companies seeking their seal of approval.

Two weeks ago, an 18-month Senate investigation found that 91% of the top rated "AAA" subprime real estate mortgage backed securities issued in 2007, and 93% of those issued in 2006, have since been downgraded to junk status.

"The subcommittee investigation found that those credit rating agencies allowed Wall Street to impact their analysis, their independence and their reputation for reliability," said Sen. Carl Levin, D-Mich., during the hearing. "And they did it for the money."

House and Senate bills would increase oversight and allow the Securities and Exchange Commission to evaluate ratings models. But the bills don't address the pay-to-play structure that is often faulted for exacerbating the financial crisis.

"The reason they haven't done anything is that ratings are just so enmeshed throughout the system, and they don't know what to replace it with," said Mark Calabria, a former Republican Senate Banking Committee staffer who now works at the Cato Institute. "It's pretty much accepted on both sides of the aisle that the rating agencies screwed up."

The bailout of the government-backed mortgage brokers is on track to become the biggest of the bailouts from the financial crisis.

In 2008, the government stepped in and took over Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500), which has cost taxpayers just shy of $126 billion, according to federal filings.

Everyone, from Treasury Secretary Timothy Geithner to House Financial Services Chairman Barney Frank, acknowledges that the mortgage finance companies are due for a makeover.

And Republicans, in particular, have made such reforms their battle cry, lambasting federal policy that they say awarded too many mortgages to many homeowners who couldn't afford them.

But Democrats aren't ready to tackle the issue in the Wall Street reforms.

"The legislation is already massive, 1,500 pages long and quite complex in the subject matter," said Brian Gardner, chief political analyst for Keefe, Bruyette & Woods, an investment bank that specializes in financial firms. "To add the GSEs and the housing finance market adds to the technical complexity and the political complexity."

Part of the problem is that Freddie and Fannie are still in crisis mode. The federal government has been using its ownership of the entities to help pump life into the housing markets.

Sen. John McCain, R-Ariz., is expected to offer an amendment Wednesday that would force the government to release its hold of Fannie Mae and Freddie Mac.

Sen. Christopher Dodd, D-Conn., said Wednesday that Congress needs to address problems at the mortgage finance firms, but he doesn't think now is the time. He added that he could support a federal study of the mortgage giants.

"It's such a huge issue," said Dodd, who runs the Senate Banking Committee. "Clearly, it's one of those areas that must be addressed ... I just want to assure my colleagues that I'm willing to support ideas that get us going in the right direction."