Five Reasons to Cheer the Financial Reform Bill

The financial reform bill is far from perfect, but it does have some good points that are worth noting.

A major financial reform bill appears likely to be signed into law sometime in the next few weeks. Hardly anybody has read all 2, 134 pages of the bill and, even those that have probably don’t know its full implications. (You can read the bill here and an executive summary here.)  But, given that passage of something seems highly likely, it’s important to try to figure out what the none-too-nicely named “Wall Street Reform and Consumer Protection Act” will actually do. Given the magnitude of the financial crisis, its numerous causes, and the enormously outdated nature of America’s financial regulatory system, some sort of legislation seems inevitable. Based on what has emerged from conferences, it’s possible to make some initial conclusions as to what the law might do. Today, I’ll list five potential positive consequences of the law and, tomorrow, I’ll provide a list of five negative consequences that seem likely.

1. The chances of bailouts will decline: Sponsors of the bill will make much of the law’s provisions that say Congress won’t bail out entities in the future and, in some cases, slightly speed up the rate at which TARP funds have to be repaid. These provisions sound good but they’re close to meaningless AS Congress alone can’t do anything that puts restrictions on future Congresses ability to legislate.  Still, two pieces of the legislation do seem to impose genuine limits on the possibility of bailouts. First, the mechanism used for non-legislatively approved bailouts, the Federal Reserve’s 13(3) lending authority, is limited although not abolished. Second, the legislation establishes a “wind down” process for organizations that can’t go bankrupt. It’s too early to tell that if any of this will work at all and some of it will likely depend on how regulators act. But, at minimum, the bill does seem like a good faith effort to prevent future bailouts given Congress’ inability to place real restrictions on future Congress’.
2. Banks will have one regulator: The legislation abolishes the Office of Thrift Supervision (OTS) and merges all of its functions in the Office of the Comptroller of the Currency. This is a good idea. The two separate banking regulators trace their history to a clear-cut division between banks (which, at one time, were stockholder owned companies that offered checking accounts and made mostly business loans) and savings and loans or thrifts (which, at one time, operated as mutual enterprises offering savings accounts and mostly mortgages). While a few regulatory differences between the two persist, the two institutions have been functionally the same from a consumers’ standpoint for just about 30 years. OTS also made some serious mistakes—it was the overseer of both AIG’s derivates operation and WaMu—and didn’t really have a reason for existing any more. A streamlined banking regulator should work better than the old system.
3. The federal government will finally have some insurance expertise: Insurance plays an enormous role in the American economy but, until now, the federal government had almost nothing to do with it. American insurers operate nationally and even globally but still deal with more than 50 different sets of state regulations. The new Federal Insurance Office which the act creates is a decidedly modest enterprise with few powers. National and global insurers, most likely, need some sort of overall federal regulation but, at least, the office is a start.
4. Securitization will be more closely monitored (with minimum government interference): Under the new law, anyone who sells a mortgaged backed security or similar instrument will have to retain at least five percent of the credit risk in the product. This will, at the margin, reduce the benefits of securitization.  But it’s a necessary step. Without it, no given private firm has a good individual reason to monitor the overall management of securitization and the government will have to do the job entirely on its own. . . a scheme that worked out beautifully with Fannie and Freddie.
5. Some of the law’s consumer protection provisions make sense: To begin with, the new Consumer Financial Protection Bureau located in the Fed doesn’t seem like the bête noir that many feared.  As promised, it seems more to consolidate existing powers and authorities than create new ones. It may cause problems and probably shouldn’t exist, but  it’s not intrinsically an awful idea. The most important consumer protections, however, come from two powers disconnected from the CFPB. First, consumers will gain no-cost access to their credit scores. Given how important and useful credit scores are, it’s perfectly legitimate for companies to make very widespread use of them for just about anything with financial implications. But requiring consumers to pay in order to see them is simply insulting and lead to enormous  suspicion of a valid business practice. The new mandates will have costs (some of which consumers will ultimately pay) but, given that credit bureaus don’t really make their money on consumers anyway, these costs are perfectly justifiable.  Second, the SEC will have the power to impose a fiduciary duty on brokers.  Current law makes it unclear—to say the least—whose interests many people who sell stocks and bonds really put first. Giving the SEC power here makes a lot of sense and can prevent things that border on fraud.

The financial reform bill is far from perfect. But it does have some good points that are worth noting as Congress decides how it wants to move forward on it.