Finally a financial overhaul bill

The big news this morning, and perhaps the biggest news since I started publishing the blog, is that a financial industry overhaul bill has finally been readied for Congress to vote on.  I began the blog sending out a mini-manifesto to the e-ethers calling for reform of the financial industry.  A bill has finally been negotiated between the Senate and the House; passage is expected some time next week.

What are the major details (partially excerpted from today’s Wall Street Journal)?

• Staunch the bleeding power.  The bill gives the Feds the ability to seize, restructure and sell-off the assets of troubled banking institutions before they need an economy destabilizing bailout.  The US Treasury would finance the unwinding of the firm’s assets, but the FDIC would run the process.  Costs would be recouped by levying fees on financial firms with more than $50 billion in assets.

Analysis: I like this provision because I like preventative medicine.  In the past, unless a bank failed, the Feds were pretty hamstrung in their ability to do anything about a failing institution.  Effectively, this is like forcing an overweight, deep-fried Twinkie eating, cardiologists’ dream patient, to go on a diet before forcing healthy insureds to bail his ass out of a series of bad behaviors and decisions.  Amen!  In this case, financial firms bloated with bad loans will be forced to rid themselves of them before taxpayers have to bail their asses out.  Amen!

• FSOC – the establishment of the Financial Stability Oversight Council.  The 10 member group would be composed of existing Federal regulators and is charged with monitoring systemic financial risks in the economy.  It has the job of recommending to the Fed stricter capital, leverage and other rules for big financial firms whose practices directly affect the economy.  Under extraordinary circumstances they would have the ability to disintegrate financial institutions.

Analysis: I am super pro this provision.  From the beginning of the blog I have nagged and nagged that there was no one regulator or body that had transparency into the whole financial system.  That meant that savvy financial firms crafted their business practices to skirt regulations and to avoid detection.  Ugh!  The power of this provision will be in the independence and courage of its members to actually say what they feel and then to act upon those feelings sans external pressure.  Without independence they will just be the “rubber stamp” crew.  Double ugh!

• The so-called Volcker Rule.  Ex-Federal Reserve Chairman Paul Volcker proposed a rule that has been included in the bill.  The rule prevents banking firms from using depositor and public monies for proprietary trading.  However, these institutions are going to be allowed to indirectly invest in riskier assets as they are allowed to invest monies in independently run hedge funds and other similar investments.

Analysis:  This kind of provision existed in financial legislation for almost 70 years in the Glass Steagall act, but was eliminated at the insistence of financial institutions in search of new revenues.  Why had this kind of law been in place to begin with?  Because financial institutions had definitively screwed this same kind of trading up in the 1930s.  It took around 10 years for them to do it again.  Open message to regulators 80 years from now: Duh!  Don’t ever rescind this kind of a rule.  Obviously I am a supporter of this provision.  I feel that deposits ought to be sacrosanct and only conservatively deployed in other investments.  That these monies were invested in super risky, speculative, leveraged trading bets is despicable.

• Regulation of derivatives (!).  Now derivatives are going to have to trade on an exchange and with regulatory oversight.  There will be capital rules imposed on derivatives traders to ensure that they are solvent.

Analysis: Again, from the beginning of the blog I decried that derivatives, one of the largest markets in the world were largely unregulated.  Ugh!  Oh, and did I mention that derivatives are also highly risky?  God damn it!  Haven’t we learned yet that Wall Street’s boys are the same as drunken, irresponsible, pyromaniac, greedy fraternity brothers?  The ethics of most Wall Street firms boils down to: ANYTHING FOR ANOTHER DOLLAR.  I am tired of it.  Especially since these same little shits have taken home untold billions of dollars in bonuses over the years in exchange for…what?  Nearly bankrupting the world economy.  Nice job fellas.

• Consumer Financial Protection Bureau.  Run by the Federal Reserve, this group would oversee financial institutions larger than $10 billion in assets that provide financial products to consumers.  The idea is to curb the abusive financial practices of credit card companies, mortgage lenders, check cashers, etc.

Analysis: I think this group is important.  However, that institutions below $10 billion in assets are excluded is a semi-truck sized hole in the wall.  Big institutions will just create hundreds of mini-companies to execute their policies.  Ultimately, this is probably a toothless piece of the bill.  I was long opposed to these sorts of consumer protection agencies.  My thinking was that there was already full information disclosure in the form of contracts between consumers and financial institutions and that it was up to consumers to read these documents.  However, I have a metaphor that has changed my opinion.  Why does the government insist that speed limits are low around schools?  That’s right, because even though every kid is taught to look both ways before crossing the street, kids sometimes forget to look even though their lives are in jeopardy.  Yes, adults are older, however, many adults have less experience making major financial transactions than they do crossing the street.  So a financial industry “speed limit” (i.e. a watchdog) is warranted in my opinion.  I just wish this one had bite behind the bark.

• Deposit insurance limits raised.  The FDIC will now insure deposits up to $250,000.

Analysis: Yes.

• Minimum mortgage underwriting standards.  Now lenders are required to verify a borrower’s: income, credit history and job status.  This piece of legislation also prevents payments to mortgage brokers (kick backs) for steering high-priced loans to lenders.

Analysis: Again, duh!  How could these sorts of things not have been legally mandated before?  In the long run this will do a tremendous service to the world.  Why?  Because as long as capitalism is all about profits there will be competitive pressures on banks to expand profits by doing things they have never done before.  That’s why banks began looking the other way when lending money in the 2000s.  Now that behavior is illegal.  Thank God!  This piece establishes massive security into the financial system.

• Small limits on securitization.  Now folks who originate loans have to keep 5% of the risk of the loans they underwrite on their books.  No more selling of the loan to a securitizer.  That is, no more “out of sight, out of mind” behavior.

Analysis: I think this is a good rule.  However, 5% is a paltry amount of risk to be born by a lending institution.  When your cousin asks to borrow money you are patently aware of the risks and so you are careful before lending.  If you could just sell the obligation immediately and only have to retain 5% of that risk, you still are going to lend the money and probably still going to treat the lending of the money as if it was done with house money.  This provision lacks teeth.

• Oversight of credit ratings agencies.  The SEC will have the ability to fine ratings agencies or de-register them if they issue too many bad ratings over time.  This proviso also gives the public the right to sue ratings agencies for “knowing or reckless” ratings.

Analysis:  I feel this is an excellent provision given one condition: the SEC must be fully funded.  As I have said multiple times on this blog, the SEC has been intentionally underfunded for generations to limit their ability to do their jobs.  Giving the SEC expanded powers is ridiculous when they are already underfunded to execute their current mandate.

• Expanded shareholder powers.  Now partial owners of businesses (shareholders) have the right to a non-binding vote on executive compensation packages.  It also gives the SEC the right to grant shareholders access to a proxy to nominate their own directors.

Analysis: Back in the early days of the blog I wrote a post that talked about some of the insidious things corporations do to castrate shareholders.  Most shareholders these days are big institutions like mutual funds.  In the past they have not demonstrated much will power in corporate governance.  Instead of fighting management when trouble was brewing (e.g. excessive pay packages, bad boards of directors, etc.) these owners would just sell their shares.  In part this was done because the costs of fighting management were excessive.  The high price of fighting was intentionally put in place by greedy bastard executives and their boards.  Ugh!!  Because the cost of fighting has been lowered, hopefully institutional shareholders will now bother to “show up” and assume the responsibility of a real owner of a business.  Don’t hold your breath.

• Hedge fund regulation.  Now the SEC has oversight of the hedge fund industry.  Hedgies are now required to register as investment advisers with the SEC and to provide information on their trades.

Analysis: Amen!  I have been calling for this since the beginning of the blog.  Finally we have almost complete transparency into the real goings on in the financial markets.  However, I am extremely concerned with the SEC budget.  Without more money the current limited SEC oversight is just going to be spread over more financial landscape.  Barbarians will likely invade while the SEC isn’t looking unless more money for more guards is funded.

There are more provisions in the bill, but these are the ones that I feel are important.  In general I rate the bill a 9 of 10.  Nearly every single thing I have been insisting on for almost two years is now in place.  Now let’s hope that Congress passes the damned piece of paper.  Let us also hope that the SEC is better funded.  If these things happen I am certain that SOLID foundations for economic growth have been established for at least another several generations.  Amen!

Jason