New Rules for Wall Street, Toughest Reform Since Glass-Stegall?
The final language for the financial reform bill has been approved. Big banks that were in deep into things they should not have been deep into during the mortgage boom, are now pretty much handcuffed. Or are they?
I’d love to do a winners + losers piece but it’s too much. No matter how disappointed I might sound, know that this legislation will be a big improvement over the status quo. So, let’s run through some of the main points in this legislation that we small investors care about most:
Derivatives: Banks will have to spin-off “some” of their derivatives business. They can still continue to hedge transactions using mostly financial derivatives. Transactions also now have to go through exchanges and clearinghouses. Sen. Blanche Lincoln’s wanted to bar banks from derivatives trading but clearly that was watered down.
Proprietary Trading: (Volker Rule) Banks can only use a small amount, 3%, of the bank’s money in risky hedge funds or private equity deals.
Consumer Protection Agency: Creates a new Consumer Financial Protection Bureau, housed within the Federal Reserve. The Fed is considered bank-friendly by the way. (Stay tuned, this could still change.) Auto dealers are exempted from oversight by this bureau. In general, this is about mortgages and credit cards. Good that the bill will protect people from predatory lending.
Brokers must now act as fiduciaries. Bill includes a new provision that gives the SEC authority to ensure that brokers act with “fiduciary responsibility” toward their clients. Hurrah! Finally!
Resolution Fund: Money to be used to unwind any big banks that get themselves into trouble.
Congress still has to vote on all of it, but that’s going to happen before you can say… “summer vacation!” When passed, the biggest impact will be the limits on proprietary trading, derivatives reform and the financial watchdog agency for consumers that may still be tweaked. So all together the new rules represent the big changes to our financial system since the Glass-Steagall Act, which was repealed in 1999. In a nutshell, Glass-Steagall was the glass wall that prevented traditional banks from becoming investment banks and investment banks from trying to become depositor based commercial banks. Nobody was confused.
The whole point was to separate the hens from the foxes with a meat cleaver and it worked really well for almost 70 years. Now we’re trying to put Humpty Dumpty back together again and some of the pieces just don’t fit. The thing is over a thousand pages long so you already know that this re-regulation is not going to be terribly effective in the ways we need it the most.
Most of the academics I talk to think the bill falls short and isn’t enough to prevent another banking crisis. Without getting crazy with technicalities, one reason is because big banks will still be able to take really stupid and dangerous risks using other people’s money, and this is what Volker was trying to prevent with his Volker Rule. Commercial banks can still speculate on certain types of high-risk derivatives. Bottom line, there are still plenty of ways for big banks to get into trouble and if history is any indicator – the banks will follow suit.
Oh yeah, then there’s that credit crunch… by restricting the use of derivatives it will get harder to borrow money from banks for the next year or so, but we’re sort of used to that now. My biggest problem with this legislation is that I don’t see it solving the real problem, which is too much alcohol in the punchbowl – meaning leverage. “Too big to fail” didn’t really seem to get addressed either since big banks that get into trouble can always go to the Fed and ask for money. And FANNIE who? Where are Fannie Mae and Freddie Mac in all those 2,000 pages? Looks like when this gets signed, Wall Street mega-firms will be crying all the way to the bank, but look closely because I doubt you’ll see any real tears.
