The political pressure to enact financial reform intensified Friday as the government accused Goldman Sachs of defrauding investors and the Senate concluded two days of hearings highlighting the assertedly lax supervision that preceded the largest bank failure in the country's history.
The mere suggestion of further impropriety at a Wall Street firm, coupled with intense hearings that laid bare regulators' unwillingness to rein in risky lending practices at Washington Mutual could significantly hamstring Republican efforts to oppose or weaken a reform bill.
"It's going to be harder for the industry to make the arguments that they have been making, and it's going to be harder for a politician to be seen as a supporter of theirs," said Douglas Elliott, a fellow at the Brookings Institution. "It increases the chances of passage, and it's likely to make for a somewhat tougher bill."
Senate Democrats are hoping to vote on financial reform this week, and GOP leaders have been scrambling to keep Republicans united in opposing it unless Democrats agree to further compromises.
But analysts said Friday that getting changes now will be tough.
"Even allegations of wrongdoing by any Wall Street firm strengthens the case for financial reform and makes it politically more difficult for anyone in Congress to oppose a strict bill," said Chris Low, the chief economist at First Horizon National Corp.'s FTN Financial.
Cornelius Hurley, a professor in the Boston University School of Law, said the Goldman lawsuit would give momentum to Senate Agriculture Committee Chairman Blanche Lincoln's derivatives bill, which is expected to be folded into regulatory reform. Lincoln's bill would force large financial companies to divest or wall off their swaps units and require derivatives to be exchange-traded.
"I think it does strengthen her hand in that argument, the gist of what she is saying is that these are very complex products and they should not be engaged in the traditional banking system which relies on trust and confidence," Hurley said. "The complaint against Goldman is exhibit A of abuse of trust and confidence."
The Goldman suit may also bolster the case for other controversial provisions such as the so-called Volcker Rule that would prevent banks from engaging in proprietary trading and investing in private-equity firms or hedge funds.
The SEC's allegations led to a selloff of financial stocks, with Goldman shares taking a big hit. Its stock fell nearly 13%, closing just above $160 a share.
The Goldman allegations come on the heels of other pressures to toughen, rather than weaken, the bill.
Sen. Carl Levin, the chairman of the Senate Permanent Subcommittee on Investigations, held two hearings this week on the failure of Wamu, charging that its primary regulator was too cozy with the thrift company.
Karen Shaw Petrou, the managing partner of Federal Financial Analytics, said in a note to clients Friday that the Levin hearings are intended to drive legislation further to the left.
"We see it as part of a push not only to pass the reform legislation in as tough a form as Democrats can get but also to rewrite a lot of the rules under current law," she wrote.
Democrats leapt on the Goldman allegation to bolster their arguments for reform.
"We don't need to know the outcome of this case to know that the opaque nature of unregulated asset-backed securities fueled the financial crisis," said Senate Banking Committee Chairman Chris Dodd. "Wall Street financial firms continue to game the system. We must pass Wall Street reform to bring practices like these into the light of day and protect our economy from another devastating blow."
Senate Majority Leader Harry Reid echoed that sentiment in a press release. "This is also why we need to pass strong Wall Street reform this year," he said. "Republicans should stop obstructing our efforts to hold Wall Street accountable so that Main Street can once again prosper."
Though many analysts predict that enough Republicans will come around to ensure passage of the Senate bill, Republican Leader Mitch McConnell persuaded all 41 GOP senators to sign a letter saying they would oppose the bill in its current form.
"We are united in our opposition to the partisan legislation reported by the Senate Banking Committee," they said in a letter.
And Republican leaders tried to argue that the Goldman suit bolsters their argument, saying the bill would perpetuate government bailouts. This argument has been widely discredited in recent days — Federal Deposit Insurance Corp. Chairman Sheila Bair, among others, has said bailouts would be made "impossible" by the bill — but the GOP continued to press the point.
"Despite President Obama's rhetoric, his permanent bailout bill gives Goldman Sachs and other big Wall Street banks a perpetual, taxpayer-funded safety net by designating them too big to fail," House Republican Leader John Boehner said in a press release.