By Dr. Lynn Reaser
Congress has approved a massive document, spanning some 2,300 pages intended to reform America’s financial system. Two primary motives drove the legislation: (1) An attempt to avoid the recurrence of financial crises and subsequent taxpayer liability and (2) To strengthen protection for consumer borrowers. What will be the effects?
The bill represents the single largest delegation of power to regulators in U.S. history. Some 350 mandates for rule-making, studies, and reports are given to the ten regulatory agencies that will have financial jurisdiction. Many of these powers have been handed to the Federal Reserve.
An oversight council will be established to monitor risks to financial markets. Regulators will have the authority to break up banks deemed “too big to fail” and to dissolve non-bank institutions that have become insolvent. Much of the trading of derivatives (financial instruments whose characteristics and values depend on an underlying asset, such as a bond, commodity, stock, or currency) would be directed to central clearing housing to make such transactions more transparent. Banks would lose some of their derivatives business.
The reliance on regulators to prevent the next financial crisis is questionable. After all, there were plenty of regulators on site prior to the 2008-09 financial meltdown. It appears that banks will still be able to conduct a sizable amount of derivatives trading; other less-regulated financial firms will take up the slack. The ability of regulators to break up or dissolve troubled financial firms should cause investors to be more cautious, but for market discipline to work, it will be critical to know which investors will be at risk for what losses.
The new consumer protection agency will be housed within the Federal Reserve. This body will have the authority to write and enforce a broad range of rules covering such products as credit cards, payday loans, and mortgages. Some consumers may be protected from “abusive” practices, but many may face higher bank fees and a reduced access to credit.
International rules (Basel III) are now being crafted to determine new capital and liquidity standards that financial institutions will ultimately need to meet. These could have a significant effect—perhaps more important than the new U.S. legislation—on the future growth of bank lending. Concerns about the global economy are likely to dampen any move to make such standards overly stringent.
In the meantime, frankly speaking, Congress has put into place a huge bureaucracy to safeguard America’s financial system and consumers. While well intended, these efforts are unlikely to prevent another “bubble” down the road and ripple effects on financial markets. Rather than relying totally on our regulators’ wisdom and effectiveness, it will be important for individuals, businesses, and investors to remain alert and informed as they perform their own due diligence.