What Financial Reform Legislation will Mean for You

Despite tension over today’s procedural vote on pending financial reform legislation, Congress seems determined to overhaul rules governing the financial sector in relatively quick fashion.

According to many officials involved in the negotiations, opposition to the cloture vote stems mainly from the fact that a bipartisan agreement will not have been reached prior to the vote, rather than from a philosophical disagreement over whether regulation is needed, with Republicans generally seeking to ensure that legislation will prevent future bank bailouts with no loopholes.

As it stands, Christopher Dodd (D-Conn.) and Richard Shelby (R-Ala.), the lead negotiators on the bill, profess to be close to an agreement, but not enough that a deal could be reached. Mr. Shelby “predicted his party would stand firm in blocking debate” until the deal was “more to their liking.”

All tussling aside, the bill seems likely to pass in some form and will have direct impacts on your financial well being. Obviously not in a tax credit or stimulus check kind of way, but by ensuring that systemic risk is eliminated from financial markets (that’s the stated goal at least). Time ("Sizing Up Seven Key Elements of Financial Reform") and the Roosevelt Institute ("Six Critical Elements of Financial Reform") show us how:

Too Big to Fail

Financial institutions would not be permitted to exceed a specific debt-to-equity ratio (the House limits it to 15:1, the Senate to 16.67:1). Both bills call for an industry-funded pool to prop up ailing banks that would prevent future taxpayer bailouts (the House proposes a $150 billion fund, the Senate $50 billion).

Derivatives

Derivatives (you most likely know them as collateralized debt obligations [CDOs] and credit default swaps) are entirely unregulated, amazing for a market valued at 450 trillion-with-a-T dollars. Both bills would make them exchange-traded, which would go about as far as one could go in terms of transparency.

Consumer Protection

One of the most contentious aspects of this bill, the Consumer Financial Protection Agency (CFPA) would either be an entirely new agency (House bill), or an independent division within the Federal Reserve (Senate bill), charged with making sure “that the financial powers that be aren’t selling predatory or otherwise unsound products.”

No matter how you view the proposed agency, President Obama’s original vision for the CFPA—one that would assume the consumer responsibilities of the Federal Reserve, FDIC, and Comptroller of the Currency—has been largely gutted. With its potential powers now limited (the auto industry is exempt from its purview), one can only wonder how effective it will truly be.

Unfortunately, this reform will likely have the most direct effect on your daily life, which probably explains why, rather than building a strong independent regulatory body or strengthening the hands of the regulatory bodies currently entrusted with consumer protection, we’ll add a watery layer on top of the bureaucracy.

Credit Ratings

Credit ratings agencies aided the financial meltdown of 2008 by allowing banks to wrap their crap in gold. Legislation from both houses of Congress seeks to diminish the importance of players like Moody’s and Standard and Poor’s by establishing new means of assessing an asset’s quality.

Both bills “try to bring more accountability…by requiring better internal risk assessment” and increased transparency, but transparency, some suspect, might have been a contributing factor to the inaccurate ratings in the first place. According to a recent New York Times article, publicizing computer models and formulas allowed banks to “reverse engineer top flight ratings for investments that were, in some cases, riskier than ratings suggested.”

If that is the case, this aspect of financial reform could prove the trickiest of all.

Securitization

Forces sellers to hold on to a portion of a security’s risk, which, in theory, should incentivize companies against putting out bad products

Hedge Funds

Requires hedge funds, currently private, to register with the SEC.

Corporate Governance

Corporate compensation committees of public companies would be “entirely made up of independent directors and companies [would have to] have a policy for taking back executive pay if that pay proves later to have been based on inaccurate financial statements.” Enforces long-term thinking.

Senator Robert Menendez (D-NJ) has also introduced an amendment that would rework “the way off-balance sheets are disclosed to investors, along with private rights of action…” The House bill does not deal with this issue.