Before you listen to pundits and talking heads, you may want to read a review by someone who's actually read the bill. It's a mixed bag. Some things are good. Some things are not so good.
Let's take a look.
I. What's In It
A. Creates Consumer Protection Agency under the Federal Reserve Bank
B. Increased capital requirements for financial institutions
C. Creates a council to identify and address systemic risk
D. Regulates most derivatives, asset-backed securities, hedge funds, mortgage brokers and payday lenders
E. Streamlines bank supervision
F. Provides shareholders with a non-binding vote on executive compensation
G. New rules for credit rating agencies
II. What It Says
A. Consumer Protection Agency
The rationale for creating this agency was because "the economic crisis was driven by an across-the-board failure to protect consumers." With this I disagree. The economic crisis, in my judgment, was caused by
- The belief that historic national upward trends in housing prices would continue, regardless of the effect of increasing demand by those whose credit would not have previously qualified them for a home;
- Granting a AAA rating securitized in part by these so-called sub-prime loans; and
- Allowing those who made these loans to completely offload their risk to purchasers of securitized loans.
I am not saying some level of consumer protection in finance is inappropriate. I am saying, however, that to say that a lack of consumer protection caused the financial crisis is an overstatement. Had ratings agencies done their job, mortgage backed securities would have been unsaleable, and no crisis would have occurred.
B. Increased Capital Requirements
Banks now need to put aside more money as a cushion against risk. The more risk taken, the more money that must be put aside. So far, so good.
In the current economy, banks, as most businesses know all too well, are reticent to lend money. They got clobbered in the economic meltdown, and are now erring on the side of caution. It's a good thing that banks are more cautious, but a bad thing that they're too cautious because without credit, business expansion is all but impossible. So, the more money they must put aside for capital, the less they'll have to lend. And that will delay economic expansion, including new hiring. Are new capital requirement bad? No.
But there will certainly be an effect, and that effect will be that businesses will find it hard to borrow. And expand. And hire.
Also, the largest banks will be required to fund a $50 billion fund dedicated liquidating to "too big to fail" banks which are insolvent. Taxpayers will be on the hook only for working capital collateralized by bank assets, and will be first in line for repayment.
Again, on the surface, a good idea, but these funds will not be available for lending either, and will further exacerbate the difficulty in obtaining business financing.
C. Financial Stability Oversight Council
A new council will be formed that will be responsible to identify and respond to emerging risks throughout the financial system. As a last resort, they'll be able to break up any company, bank or not, that threatens US financial stability.
A good idea, but, as with anything, it will be as good as its members. Chaired by the Treasury Secretary, it will also include regulators from the Federal Reserve Board, SEC, CFTC, OCC, FDIC, FHFA, the new Consumer Financial Protection Bureau.
D. Regulates Derivatives, etc.
During the height of the mortgage boom, financial institutions collected fees for guaranteeing each others' mortgage portfolio. As long as everybody was repaying their loans, that was fine. When things went south, though, these so-called insurance promises were called in. AIG, Bear Stearns and Lehman Brothers had issued lots and lots and lots of these promises, and you know what happened when the banks started experiencing mortgage losses. Bear and Lehman went bankrupt, and taxpayers rescued AIG, which had made more promises than they could possibly repay.
Now, most derivatives will be traded on an exchange, so we'll all know about how many are issued and can theoretically stop problems based in making promises that can't be kept before they become too large.
Banks must trade most derivatives in subsidiaries (which are not insured by FDIC, and therefore not available for taxpayer bailout), except interest-rate swaps, foreign exchange swaps and instruments deemed as “hedging for the bank’s own risk.”
As always, the devil is in the details. FDIC, under this bill, will be on the hook for interest-rate swaps, foreign exchange swaps and "hedging for the bank's own risk." We'll need to make sure somebody's watching these exceptions closely, or the taxpayers will find themselves on the hook for a hedge that the bank convinced regulators was "for its own risk."
Hedge funds are now officially investment advisers (making one wonder exactly what they were before).
The big (if boring) news is that there is now an Office of National Insurance under the Treasury Department. Hopefully, this will be the first step in regulating insurance on a national, rather than State level, which will encourage more competition and - hey, that might even serendipitously bring down health insurance costs.
E. Streamlined Bank Supervision
State chartered banks and thrifts under $50 billion will be regulated by the FDIC.
All nationally chartered banks and federal thrifts, and the holding companies of national banks and federal thrifts with assets below $50 billion will be regulated by the OCC.
Banks and thrift holding companies with assets of over $50 billion will be regulated by the Federal Reserve.
While technically, this will preserve the state banking system that governs most of our nation’s community banks, the reality is that small community banks are likely to put themselves up for sale now that they have 2000 pages of regulatory compliance to deal with. I used to do that job, and speak from experience. A community bank with 75 employees would need to dedicate 10% of its staff to compliance. Not feasible.
F. Provides Shareholders Non-Binding Vote on Executive Compensation
Non-binding is the operative word here.
G. Credit Reporting Agencies
I blame the majority of the economic meltdown on credit reporting agencies. Had they done their job, mortgage backed securities would have been rated as what they were - risky. Few would have bought them. Investment bankers would not have been able to sell their risk in extending loans to people who couldn't afford them, and would have stopped making those loans.
Now, there will be an Office of Credit Ratings at the SEC. Yes, the same SEC that was responsible for overseeing Bernie Madoff. Analysts will now have to pass exams, compliance officers will be forbidden to perform sales, and the SEC can deregister an agency for providing bad ratings over time.
My reaction to this is probably about the same as yours. Too little. Too late.
III. Brace Yourself
Bank loans will be harder to get.
Bank fees will go up.
Watch for the exceptions in this legislation to be the source of the next financial meltdown.
There will be another financial meltdown.
Fear and greed cannot be legislated out of the financial system, but this legislation is better than nothing.