Wall Street reform stuck on consumer protection

WASHINGTON (CNNMoney.com) -- As the Senate continues to debate Wall Street reform for the next few weeks, there is one issue that could threaten final passage: Consumer protection.

The Senate voted 61-38 -- mostly along party lines -- to oppose a Republican consumer protection alternative on Thursday, signaling a political divide on the issue.

Democrats and Republicans have been arguing about consumer protection for months without making any compromise. And this is the one area that, so far, neither side has shown any willingness to bend on.

While political divisions have taken a back seat in many parts of the Wall Street reform bill, they've been front and center on the issue of creating a new agency to monitor consumer protection.

Democrats put more faith in the ability of government, or in this case, a consumer financial protection regulator, to police private industry. Republicans worry about government overreaching.

"This is a pretty purely partisan issue in a traditional sense, and it would have been a partisan issue even if it had less visibility," said Steve Verdier, senior lobbyist for the Independent Community Bankers of America.

The Democratic proposal would create a Consumer Financial Protection Bureau inside the Federal Reserve. The bureau would wield new rule-making powers to ban financial products. It can enforce those rules at the largest banks and at financial firms not regulated, like mortgage originators, auto loan financiers and payday lenders. Smaller banks would also have to abide by the rules, but they'd be overseen by their existing regulator.

The Democrats' consumer regulator could do things like ban and phase out penalty fees that homeowners face when paying down their mortgages early. The regulator could cap certain kinds of credit card fees if deemed abusive. It must also get feedback from existing regulators when they're creating the new rules. And a panel of existing regulators can veto rules that dig too deeply into banks' balance sheets.

The Republican alternative authored by Sen. Richard Shelby, R-Ala., couldn't be more different from the Democratic version.

It moves the consumer regulator inside the Federal Deposit of Insurance Corp. and exempts most banks, credit unions, auto lenders and pay day lenders from tougher new rules. New consumer protection rules would mostly impact nonbanking mortgage originators and any financial firm that is a "repeat violator," of consumer protection laws, Shelby said.

Also, the FDIC board of directors would have to approve any new consumer rules.

The Shelby amendment addresses Republicans' biggest criticism of the Democrats' consumer protection proposal by ensuring that no new consumer protection rule would trump banks' balance sheets.

"An ill-conceived consumer protection rule could cause banks to fail," Shelby said. He said his amendment would empower the FDIC to go after those who aren't currently regulated "without needlessly subjecting law-abiding business to broader regulation."

Democrats say the Shelby consumer protection alternative would weaken the current state of consumer protection.

"This substitute is worse than the status quo. It's a major step backward," said Sen. Christopher Dodd, chairman of the Senate Banking Committee. "It's a stimulus package for scam artists."

President Obama addressed the Republican amendment on Thursday in a statement, saying it read like it was "written by Wall Street's lobbyists."

"This amendment will significantly weaken consumer protection oversight, includes dangerous carve outs for payday lenders, debt collectors, and other financial services operations, and hurts the ability of community and local banks to compete by creating an unlevel playing field with their non-bank competitors," the statement said.

The big question is whether lawmakers can work out a compromise that will draw enough Republicans to overcome a potential filibuster on the overall bill.

"They will definitely work out a compromise that picks up the necessary Republican votes," said Doug Elliott, a fellow at the Brookings Institution and a former investment banker. "The end result will be a regulator with more independence than the Republicans want and less than the Democrats want."

Shelby wouldn't say whether he'd oppose the overall bill if his amendment didn't pass, adding "we'll just keep working the process."

But Sen. Corker said he's working on ways to "surgically alter," the Dodd bill to make sure banks wouldn't be weakened by new consumer rules.

"Hopefully if this doesn't pass, there will be ways to surgically deal with it," Corker said.