Financial Reform Bill A Progressive Step Forward

The recent financial crisis that drove this country to the precipice of a second great depression cost us 8 million jobs, more than $4 trillion in residential real estate value alone, and wiped out the nest egg of countless millions.  All through this time though, titans on Wall Street got richer and richer, thanks to a deregulated financial sector.  Sub-prime mortgages, near-zero consumer protection, financial executive compensation structures with no real connection to performance, and collusion between credit ratings agencies and financial firms.

After a long wait, Congress has now passed a financial reform bill that the President is poised to sign this week.  Before we discuss some of the provisions I believe are most important, I'd like you to watch the President's speech on the passage of this bill.

As a result, it is important that the financial reform law address all of these things.  Does it?  In my opinion, it does.  A full summary of the Dodd-Frank bill is posted on the Senate website.  I want to focus on the specific areas I address above.

Independent Consumer Protection Bureau

This, I believe is perhaps the most important area of reform.  Perhaps that view is biased due to my own position as a consumer, but it's a bias that would fit most Americans.  The final bill creates a Bureau of Consumer Financial Protection (BSFP) housed within the Federal Reserve and funded by the Fed, but not controlled by the Fed.  The consumer protection functions of various agencies are consolidated into this new independent bureau that is charged with regulating consumer protection with respect to big financial institutions.  The BSFP has independent powers to write consumer protection rules and to enforce them via fines, civil litigation (with authority to refer criminal matters to DOJ) and subpoenas.

A Financial Stability Oversight Council - that is mostly charged with regulating "too big to fail" institutions with systematic risk and winding down institutions at risk - also has the authority to override BSFP protections if they believe it to endanger the whole system.  However, they may do so only with 2/3rds vote.

For more on consumer protection, see this comparison.  The Senate version is the version for the final bill.

New Mortgage Regulations

Not only would the new bill require lenders to ensure that borrowers are able to repay their loans, the bill would force lenders to retain a stake in the mortgage loans they issue, instead of being able to chop it all up and sell it all off.  It prohibits banks from incentivizing brokers to lure consumers into more expensive loans, and forces lenders to disclose the highest possible interest paid on a variable interest rate mortgage.  It outlaws a nefarious practice by banks to penalize borrowers if they - God forbid - pay back their loans too quickly (pre-payment penalties), depriving the lender of precious interest.  If banks violate these standards, they will not be able to foreclose on their mortgages.

Executive Compensation

The bill gives shareholders a non-binding but public vote on executive compensation as well as golden parachutes.  Do I wish the vote was binding? Yes.  But a public vote will give shareholders a responsible role to play - they can divest from corporations that defy their shareholder wishes.  It puts corporate boards in a position of having to defy their own shareholders if they wish to up executive compensation.

The bill also gives the Securities and Exchange Commission the ability to grant shareholders access to corporate ballots.  Without reform, such access is only limited to Boards of Directors only.  This will give pension funds and other public interest investors a say in who is on the ballot to be on corporate boards.  Simply put, this democratizes corporate elections, and gives shareholders a fighting chance.

Banking Regulations

A version of the Volcker Rule - a rule prohibiting proprietary trading by banks as well as the investments of bank funds in Hedge funds (with some exceptions in which investors have skin in the game, and only up to 3% of common stock and retained earnings) - has made it into the final legislation.  It could be stronger, but it's significant reform.

The legislation awaiting the President's signature now also forces most derivatives to be traded on an open exchange.  It gives the SEC and CFTC (Commodities Futures Trading Commission) the authority to regulate derivatives, including the ability to impose capital requirements.

The bill also increases transparency of the Federal Reserve by authorizing an audit by the Government Accountability Office (GAO), Congress' investigative arm, on the emergency lending by the Fed during the financial crisis.  The Feds are required to disclose the terms of such loans and other transactions on an ongoing basis.

On the subject of "too big to fail," the legislation creates a Financial Stability Oversight Council, chaired by the Secretary of Treasury and empowered to impose additional regulations on financially unstable and economically significant institutions and wind down such financial institutions in a timely and orderly manner.  The costs for such winding down is paid by the institution and their industry peers, sparing taxpayers the cost.

In addition, the SEC is charged with stopping issuers of assets-backed securities from picking their own credit ratings agencies. Credit ratings agencies can be fined by Office of Credit Ratings in the SEC.  The new bill also requires that at least half the members of the boards of the nationally recognized credit ratings agencies to be independent, with no financial stake in rating companies.


Will this bill end "too big to fail" once and for all?  Probably not, but it will sure has heck make it a lot harder to repeat.  The answer to the question of whether recent disaster would happen if these protections were in place at the time of the collapse is almost certainly negative. The combination of consumer protection, financial stability oversight, easier ballot access for shareholders and banking regulatory overhaul will make it significantly harder for a volatile institutions to imperil the entire financial system.  The kind of lawless, regulation-less Wall Street regime that brought on the recent disaster will no longer be possible.  One can certainly argue that financial institutions will find loopholes or certain regulations could be made stronger.  But no one should defend the idea that this isn't significant reform.

It is important to look at the totality of reform - any reform.  In totality, this financial reform bill should stand the test of time.  That should not, however, mean that we stop our push for further reform.  We should use this current reform as the building blocks of further, stronger, more progressive reform of the financial markets in this country.

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