WASHINGTON – Congressional negotiators early Friday approved the most sweeping overhaul of U.S. financial regulation since the Great Depression, reshaping oversight of Wall Street.
Lawmakers from the House and Senate worked through the night in a 20-hour session to reach deals on a ban on proprietary trading by banks and oversight of the derivatives market. This month, they’ve also agreed on measures to wind down big firms whose collapse might shake markets, to keep tabs on hedge funds and to make it easier for investors to sue credit rating companies.
“When one says this is the biggest change in our financial regulation in 70 years, that’s not an exaggeration,” Stuart Eizenstat, former deputy Treasury secretary under President Bill Clinton, said Friday in an interview in Washington. “This is much more profound and much more far-reaching because it really deals with the new financial world that was created in a way by the end of Glass-Steagall.”
A committee of lawmakers from the House and Senate spent two weeks reconciling the bills passed by each chamber. The legislation still needs to be approved by the full House and Senate. Congressional leaders aim to hold those votes next week and present it for President Barack Obama’s signature by July 4.
“This is going to be a very strong bill, and stronger than almost everybody predicted that it could be and that I, frankly, thought it would be,” House Financial Services Committee Chairman Barney Frank, D-Mass., told reporters June 23 as lawmakers prepared for the final round of talks.
The bill seeks to protect consumers, curb risks, boost surveillance of emerging threats to markets and give regulators more emergency powers to avoid future taxpayer-funded bailouts of too-big-to-fail firms.
“They are huge accomplishments,” Senate Banking Committee Chairman Christopher Dodd, D-Conn., told reporters June 23.
Whether the legislation – now named the Dodd-Frank bill – takes the right steps, or goes far enough, is still a matter of debate.
“It doesn’t reform anything, not anything that needs to be reformed,” said William Isaac, the former chairman of the Federal Deposit Insurance Corp. and now chairman of Fifth Third Bancorp, in a June 23 interview. “We haven’t done anything to repair this 100-year-old regulatory structure.”
What follows are the scope, impacts and impetus for some the major provisions, based on the language lawmakers agreed to as of early this morning in Washington.
- Topics
- ‘Volcker Rule’
- Derivatives
- Consumer Financial Protection
- Credit and Debit Cards
- Financial Stability Oversight Council
- Bank Capital Rules
- Federal Reserve
- Credit Raters
- Private Equity and Hedge Funds
- Unwinding Failed Firms
- Risk Retention
- Fiduciary Duty
- Insurance Industry
The Obama administration’s proposal to ban banks from proprietary trading, nicknamed the Volcker rule after former Federal Reserve Chairman Paul Volcker, was softened by Senate negotiators.
Banks will be allowed to invest in private-equity and hedge funds, though they will be limited to providing no more than 3 percent of the fund’s capital. Banks also can’t invest more than 3 percent of their Tier 1 capital.
The change, offered by Dodd, alters language in a bill the Senate approved in May, which would have barred banks from sponsoring or investing in private-equity and hedge funds. Lawmakers offered the modification to appease Sen. Scott Brown, R-Mass., who was concerned the ban would harm Boston-based State Street Corp. He was one of four Republicans to break party ranks and vote for the Senate bill.
Senate negotiators also agreed to give regulators less say than previously proposed to define a ban on proprietary trading. Dodd backed a change offered by Democratic Sens. Jeff Merkley of Oregon and Carl Levin of Michigan that “more clearly defines the limits on proprietary trading” by writing the ban into the legislation. The earlier Senate bill would have let regulators write it.
The ban on propriety trading, in which a company bets its own money, may reduce profits. Goldman Sachs Group Inc., the most profitable firm in Wall Street history, has said proprietary trading generates about 10 percent of its annual revenue. The firm made $1.17 billion in 2009 from “principal investments,” which include stakes in companies and real estate, according to a company filing.
Dodd backed a Merkley-Levin plan to prevent firms that underwrite an asset-backed security from transactions that would result in a conflict of interest.
The conflict-of-interest provision seeks to address fraudulent conduct alleged in a Securities and Exchange Commission lawsuit against Goldman Sachs. The SEC claims the bank created and sold collateralized debt obligations linked to subprime mortgages without disclosing that hedge fund Paulson & Co. helped pick the underlying securities and bet against the vehicles. Goldman Sachs has denied wrongdoing. –Alison Vekshin
After spending months crafting legislation, lawmakers pushed through a last-minute deal on what they termed the most challenging part of their task – establishing for the first time a regulatory structure for the $615 trillion over-the-counter derivatives market.
The most contentious part of the derivatives rules is a provision that will force banks to push some of their swaps- trading into subsidiaries, on the theory it would reduce taxpayers’ risk if the trades are walled off from depositary institutions that enjoy federal benefits such as access to the Federal Reserve’s discount lending window.
The original proposal by Sen. Blanche Lincoln, D-Ark., who is chairman of the Senate Agriculture Committee, would have banned all swaps-trading by commercial banks. It touched off intense lobbying from opponents including the banking industry, banking regulators, the Obama administration and lawmakers of both parties who said the proposal could drive up costs for businesses and send business to foreign lenders.
In the final hours of negotiations, President Barack Obama’s financial overhaul specialists – Deputy Treasury Secretary Neal Wolin; Michael Barr, Treasury’s assistant secretary for financial institutions; and Diana Farrell, the deputy director of the White House’s National Economic Council – gathered at the Dirksen Senate Office Building while House and Senate members of the conference committee waited downstairs for a deal.
In the end all parties agreed that banks will be able to maintain their trading operations so long as they are used to hedge risk or trade interest rate or foreign exchange swaps, a victory for banks that were on the verge of losing the desks entirely. The proposal will force a fundamental shift in the industry, giving federally insured banks up to two years to send instruments such as un-cleared credit default swaps off to a separately capitalized subsidiary.
“We target the riskiest players and ask more of them, as we should,” Lincoln said Friday.
Derivatives took a central role in the debate over Wall Street regulation after losing bets on swaps tied to mortgage-backed securities pushed New York-based insurer American International Group Inc. to the brink of bankruptcy in 2008. Derivatives are contracts whose value is derived from stocks, bonds, loans, currencies and commodities, or linked to specific events such as changes in interest rates or the weather.
Beyond the swaps-desk provision, the Senate legislation will push most over-the-counter derivatives through third-party clearinghouses and onto regulated exchanges or similar electronic systems, a measure that will make it easier for the market and regulators to track the trades. It will mean higher margin costs on some transactions.
Regulators also will be required to impose heightened capital requirements on companies with large swaps positions, and would be given the authority to limit the number of contracts a single trader can hold.
Businesses that use derivatives to hedge risk from producing or consuming commodities, deemed “end users,” will be exempt from the clearing requirements if the activities were being undertaken as a way to hedge legitimate business risk.
“There are some that want more restrictive language than I do and there are those who want to open up the barn door,” Lincoln said. “I think we have reached a good compromise here.”
Selling over-the-counter derivatives is among the most lucrative businesses for the largest financial companies. U.S. commercial banks held derivatives with a notional value of $212.8 trillion in the fourth quarter, according to the Office of the Comptroller of the Currency. JPMorgan Chase & Co., Citigroup Inc., Bank of America Corp., Goldman Sachs and Morgan Stanley hold 97 percent of that total.
While JPMorgan and Citigroup might have to spend billions to re-capitalize their trading desks, the three others might have much smaller costs. Morgan Stanley and Goldman Sachs both entered the commercial banking business in 2008 in the midst of the financial crisis, and will be less affected. Morgan Stanley kept just over 1 percent of its $86 billion in derivatives holdings in its bank in the first quarter, and Goldman Sachs held 32 percent of its $104 billion. Bank of America, which absorbed broker-dealer Merrill Lynch in 2009, had 33 percent of its $115 billion in its bank. –Phil Mattingly
A consumer financial-protection bureau will be created at the Federal Reserve to police banks and financial-services businesses for credit-card and mortgage-lending abuses. The plan was approved over the objections of Republicans and the financial industry.
Obama originally proposed a stand-alone consumer agency, saying it would play a central role in reorganizing regulation to prevent future financial crises.
“It’s an agency with considerable authority to protect consumers from abusive financial practices, which is a landmark achievement,” Travis Plunkett, legislative director at the Consumer Federation of America, said in an interview.
While the bureau will be housed at the Fed, it will have independent authority. Led by a director appointed by the president and confirmed by the Senate, the bureau will write consumer-protection rules for banks and other firms that offer financial services or products. It will enforce those rules for banks and credit unions with more than $10 billion in assets. Bank regulators will continue examining consumer practices at smaller financial institutions.
The bureau could require credit-card lenders, including JPMorgan Chase and Citigroup, to reduce interest rates and fees. Mortgage lenders, including Bank of America, may be subject to tougher rules including more upfront disclosures to borrowers about loan terms.
Automobile dealers won an exemption from oversight by the bureau after lobbying from the industry. Dealers said the rules would place unnecessary restrictions on their financing business. The Obama administration had opposed the exemption.
The idea for a new agency grew out of criticism from lawmakers and consumer groups that bank regulators, including the Fed, failed to properly exercise their consumer-protection authority during the housing boom. The consumer bureau will assume much of that oversight. The bureau’s rules could be overridden by the new Financial Stability Oversight Council if the panel decided that they threatened the safety, soundness or stability of the U.S. financial system.
The financial-services industry lobbied against the new bureau, saying it would raise costs, limit choice and improperly separate oversight of consumer issues and safety and soundness. –Alison Vekshin
The Federal Reserve will get authority to limit interchange, or “swipe” fees, that merchants pay for each debit-card transaction. The measure, pushed by Sen. Richard Durbin, D-Ill., lets retailers refuse credit cards for purchases under $10 and offer discounts based on the form of payment.
The measure also directs the Fed to issue rules that let merchants route debit-card transactions on more than one network. That “provides additional competition to a previously non-competitive part of the market,” Durbin said in a statement June 21.
Visa Inc. and MasterCard Inc., the world’s biggest payments networks, set interchange rates and pass that money to card-issuers including Bank of America and JPMorgan. Interchange is the largest component of the fees U.S. merchants pay to accept Visa and MasterCard debit cards. The fees totaled $19.7 billion and averaged 1.63 percent of each sale last year, according to the Nilson Report, an industry newsletter.
The industry fought off earlier efforts to regulate interchange fees, including a Durbin-sponsored bill that remains in committee, by saying the income is needed to offset the risk of lending money. That argument doesn’t apply to interchange on debit cards, which tap funds in consumer checking accounts. Shifting the focus to debit cards may have helped win support from some Republicans, with Sen. Susan Collins of Maine calling the scaled-down version a “reasonable approach.”
The amendment directs the Fed to ensure that debit-swipe fees are “reasonable and proportional” to the cost of processing transactions. The provision will take effect a year after enactment.
Durbin altered his proposal to exempt lenders with assets of less than $10 billion, or 99 percent of U.S. banks. That failed to win the support of trade groups representing community banks and credit unions, who said the measure will make their cards more expensive than those issued by bigger lenders. –Peter Eichenbaum
Financial Stability Oversight Council
The bill will establish the Financial Stability Oversight Council, a super-regulator that will monitor Wall Street’s largest firms and other market participants to spot and respond to emerging systemic risks. The Treasury Department will lead the panel, which includes regulators from other agencies.
“The idea of the council is to look at the interconnection of highly leveraged financial firms,” said Jim Hamilton, a senior law analyst at Riverwoods, Ill.-based CCH Inc., which provides information to businesses about regulatory changes. “No one was able to do that before the financial crisis.”
With a two-thirds vote, the council can impose higher capital requirements on lenders or place broker-dealers and hedge funds under the authority of the Fed. The council also will have authority to force companies to divest holdings if their structure poses a “grave threat” to U.S. financial stability.
The nine-member council will include regulators from the Fed, Securities and Exchange Commission, Federal Housing Finance Agency, Commodity Futures Trading Commission and other agencies. State securities, insurance and banking regulators and credit unions lobbied for and won non-voting seats.
The Federal Home Loan Banks system, a financing co-operative for mortgage lenders, also won an exemption from council oversight after saying limits on credit concentration could cut its lending capacity in half.
Trade groups including the American Bankers Association supported the measure. Consumer groups including the Center for Responsible Lending objected to the council’s power to overrule the consumer financial-protection bureau at the Fed. –Lorraine Woellert
The bill may force some banks to shore up capital. An amendment introduced by Collins, the Maine Republican who joined Democrats in voting for the broader bill, will bar bank holding companies from keeping less capital than their bank subsidiaries. That will have an impact on the use of trust preferred securities, known as TruPS. Lawmakers bowed to pressure from banks, agreeing to a transition period for large firms and grandfathering of the securities for smaller lenders.
Banks with assets of at least $15 billion will get five years to replace TruPS with common stock or other securities that count as capital. Community banks that have raised cash through TruPS since 2000 will, in effect, get 20 years to make the switch because most of the securities have 30-year maturities. Smaller lenders sold roughly $45 billion of the $150 billion in TruPS issued by U.S. banks, which packaged them into collateralized debt obligations.
TruPS now count toward equity when calculating capital ratios – a bank’s cushion against losses – while being treated like bonds for tax purposes.
Regional banks such as McLean, Va.-based Capital One Financial Corp. and Buffalo, N.Y.-based M&T Bank Corp., which rely heavily on TruPS, will be hurt most, according to Richard Bove, an analyst for Rochdale Securities. Banks unable to replace the TruPS will have to shrink their balance sheets to stay within the minimum capital rules dictated by regulators.
“It will disadvantage not just U.S. banks, but U.S. businesses and consumers as well,” Barclays Plc President Robert Diamond said in Washington before the rule was completed. Removing the TruPS held as capital could restrict lending by as much as $1.5 trillion, Diamond said, echoing a point made by bank lobbying groups.
The Collins language also will require the U.S. holding companies of overseas banks, such as Barclays, to comply with the same capital rules as domestic lenders. For now, they’re exempt as long as their foreign parents are regulated by an entity recognized by the U.S.
The FDIC backed the Collins amendment, saying TruPS don’t provide the cushion they were meant to. Banks couldn’t use them as capital during the financial crisis because deferring dividends would have been seen as a sign of weakness, the FDIC said.
The rule will have “minimal, if any” impact on banks’ ratings because TruPS are already being disqualified as capital by analysts, Moody’s Investors Service said this week. –Yalman Onaran
The Federal Reserve will have a broadened supervisory scope and be subject to the most transparency in its 96-year history after negotiators rejected threats to its political autonomy and bank-oversight powers.
Chairman Ben S. Bernanke will have a seat on the newly created Financial Stability Oversight Council. That board will deputize the Fed to set tougher standards for disclosure, capital and liquidity. The rules will apply to banks as well as non-bank financial companies, such as insurers, that pose risks to the financial system.
Earlier drafts of Senate legislation would have curtailed the Fed’s bank supervision. Lawmakers approved an amendment by Sens. Kay Bailey Hutchison, R-Tex., and Amy Klobuchar, D-Minn., maintaining the powers. That avoided a clash with House members over the issue. Under the bill, the Fed will keep supervising larger banks including Bank of America and Goldman Sachs and smaller firms such as Central Virginia Bankshares Inc., with assets of $471 million.
U.S. central bankers face a one-time audit of emergency loans and other actions taken to combat the financial crisis since 2007. Under another change, the central bank, after a two- year delay, will have to identify firms that borrow through its discount window and participate in the Fed’s purchases or sales of assets, such as mortgage-backed securities.
Senators and House members voted down a tougher audit measure, which would have removed the Fed’s 1978 shield from examinations of interest-rate decisions. That plan, previously approved by the House, was opposed by Bernanke and other Fed officials, who said it risked politicizing monetary policy.
Fed governance will also change. Commercial banks will be ineligible to participate in selecting all 12 regional Fed chiefs, leaving the task to non-bankers chosen by lenders and the Fed’s Board of Governors. One of the seven Fed governors will be a second vice chairman in charge of supervision. Conferees rejected a Senate plan to make the New York Fed president a political appointee. –Scott Lanman
Ratings companies, including Moody’s Corp. and McGraw-Hill Cos.’ Standard & Poor’s unit, may avoid a plan to have regulators help pick which firms grade asset-backed securities. Congress also softened a proposed liability provision, making it harder for investors to sue credit-raters than under language approved by the House in December.
The overhaul legislation requires the SEC to conduct a two- year study on whether to create a board to decide who rates asset-backed securities. That curbed a Senate proposal to establish the board with SEC oversight. After the study, the board would be established only if regulators can’t come up with a better alternative.
Profits grew at Moody’s and S&P, both based in New York, during the U.S. housing boom because Wall Street paid them to assess the creditworthiness of mortgages packaged into bonds. After the housing market collapsed in 2007, pension funds and banks that lost money on the securities blamed credit-rating companies for assigning the assets their highest AAA rankings.
Lawmakers also adopted language that redefines what investors must show to prevent a judge from dismissing a lawsuit against a credit rater. Litigation may proceed if investors demonstrate a company “knowingly or recklessly” failed to conduct a “reasonable” investigation before issuing a rating. The ratings firm could also avoid being sued by hiring an independent company to do the investigation.
Legislation approved by the House in December would have required investors meet a lower threshold of evidence, showing that a ratings company was “grossly negligent” in issuing a grade. Current law requires investors to demonstrate they were intentionally misled.
The purpose of the Senate bill was to give credit-rating companies an incentive to conduct “adequate due diligence,” without subjecting them to lawsuits that could “easily bankrupt” them, John Coffee, a securities law professor at Columbia University in New York, wrote in a June 16 paper.
Credit-rating companies will respond to the Senate language by adjusting their business practices, Peter Appert, an analyst with Piper Jaffray & Co., wrote in a June 21 note to clients.
The resolution of regulatory uncertainty that has driven down Moody’s and McGraw Hill shares presents an “appealing” buying opportunity, he wrote. Moody’s has plunged about 68 percent over the past three years in New York Stock Exchange trading. McGraw-Hill has fallen 56 percent in three years. –Jesse Westbrook
Private Equity and Hedge Funds
Large hedge and private equity funds will be forced to register with the SEC, subjecting them to mandatory federal oversight for the first time. Venture capital funds were exempted from the registration rule.
Hedge funds, in particular, pushed for the registration requirement, which is less burdensome than the regulations being imposed on banks. In lobbying Congress, the private pools of capital argued that they shouldn’t be heavily regulated because they didn’t cause the financial crisis. Nor were they bailed out by taxpayers.
Registration subjects funds to periodic inspections by SEC examiners. Any firm with $150 million or more in assets, such as ESL Investments Inc. and Soros Fund Management, will be covered by the law. Funds also must hire a chief compliance officer and set up policies to avoid conflicts of interest.
Hedge and private equity funds will be required to report information to the SEC about their trades and portfolios that is “necessary for the purpose of assessing systemic risk posed by a private fund.” The data, kept confidential, could be shared with the Financial Stability Oversight Council that the legislation sets up to monitor potential shocks to the economic system.
Complying with registration rules may cost hedge funds as much as $500 million in the first year, said Judith Gross, founder of JG Advisory Services LLC, a New York-based consulting firm to the hedge-fund industry. The estimate is based on 2,000 new registrants and reflects the cost of implementing necessary compliance procedures.
Should the government determine a fund has grown too large or is too risky, it would be placed under Fed supervision.
Restrictions on banks’ ability to own hedge and private equity funds and trade for their own accounts may benefit the funds that are subject to less regulation. The bill could push new investment and trading talent toward the industry. Limits on leverage and stiffer capital requirements for banks may also give hedge and private equity funds an edge landing investors chasing bigger returns. –Robert Schmidt
The bill gives the FDIC, which already has authority to liquidate failed commercial banks, power to unwind large failing financial firms whose collapse would roil the economy.
Regulators will have clout they lacked during the financial crisis when, instead of seizing flailing companies such as AIG, the government kept them afloat with a $700 billion taxpayer-funded bailout. Had such authority existed in September 2008, it might have been applied to Lehman Brothers Holdings Inc., whose bankruptcy that month froze credit markets and helped spur Congress to approve the Troubled Asset Relief Program.
The House approved a version of the bill in December that proposed a $150 billion fund, to be paid for by the financial industry, to cover the government’s cost of unwinding failing firms. Dodd proposed a similar fund of $50 billion in a Senate version of the bill, which was assailed by Republicans as a perpetual bailout of Wall Street firms. The protests stalled consideration of the legislation on the Senate floor.
Dodd agreed to drop the fund to allow debate on the bill to begin. Under the revised measure, the costs of unwinding failing firms will be borne by the financial industry through fees imposed after a firm collapses. The bill explicitly bars the use of taxpayer funds to rescue failing financial companies. –Alison Vekshin
The legislation will force lenders, with the exception of some mortgage providers, to hold at least a 5 percent stake in debt they package or sell. The provision is designed to rein in the trade of easy credit blamed for fueling the financial crisis.
The rule will affect credit-card debt, auto loans, mortgages and other securitized debt. Issuers of asset-backed debt and the originators who supply them with pools of loans, including credit-card companies such as Riverwoods-based Discover Financial Services, will be forced to retain some of the credit risk. The goal is to align the issuers’ interests with those of the investors who buy their financial products.
The provision will curtail lending and raise consumer costs, said Tom Deutsch, executive director of the American Securitization Forum, a New York trade group that represents issuers, investors and other participants in the market.
“These risk-retention provisions will curtail overall lending to an extent across all types of credit products,” Deutsch said in an interview. “The result may improve some lending standards, but it will also have the consequence of reducing the overall availability of credit.”
Lawmakers exempted many mortgage lenders from the rules after lobbying by brokers and community banks, who said forcing lenders such as Bank of America to keep loans on the books would tie up capital and lead to higher interest rates. The exemption wouldn’t apply to mortgages with features that increase risk, such as negative amortization, interest-only payments and balloon payments.
The exception is “tremendously important,” said Glen Corso, managing director of the Community Mortgage Banking Project, a coalition of lenders. “The exemption will ensure the continued availability of stable, affordable, low-risk mortgages.”
Loans guaranteed by the Federal Housing Administration, U.S. Department of Agriculture, and U.S. Department of Veterans Affairs also will be exempt from retaining risk. The three agencies last year guaranteed more than 30 percent of new mortgages as private capital fled the market after the collapse of the housing bubble.
Sellers of commercial mortgage-backed securities won language giving regulators flexibility to tailor risk-retention rules to specific products. For example, regulators could set underwriting standards as a form of risk retention. –Lorraine Woellert
Lawmakers scrapped a proposal that would have made securities firms more accountable to individual investors. Instead, the SEC is required to study whether changes are necessary.
The debate focused on whether stock brokers who offer clients investment advice should have a fiduciary duty that requires disclosure of all conflicts and restricts marketing to products that are in customers’ best interests. Currently, brokers must only ensure that a stock or bond is suitable before selling it to a client.
Consumer advocates have said the fiduciary obligation is needed because investors are sold products they don’t understand or can be confused by titles used by financial advisers. Banks and insurance companies lobbied against the change, saying people selling securities shouldn’t be regulated the same way as professionals who invest money for clients.
The House-Senate panel agreed to let the SEC impose a fiduciary duty on brokers once the regulator completes a six- month study. House lawmakers had earlier proposed implementing stiffer rules without an SEC review, prompting opposition led by Sen. Tim Johnson, D-S.D. –Jesse Westbrook
The bill creates a new Federal Insurance Office within the Treasury to monitor insurers, and requires a study that will recommend ways to further overhaul regulation of the industry. Industry groups say a new layer of oversight may complicate compliance and increase costs.
The measures were prompted by the near-collapse of New York-based AIG in 2008. The insurer, then the world’s largest, got a $182.3 billion taxpayer bailout after failing to set aside enough money to cover obligations on credit-default swaps linked to subprime mortgages.
Insurers, which are mainly regulated by states, will now have to deal with a national watchdog. State insurance commissioners are concerned federal oversight will interfere with rules already in place. Insurers are concerned that they will have to devote more resources to answer to multiple officials.
“Half of our companies are farm- and county-mutual companies,” said Dylan Jones, federal affairs director of the National Association of Mutual Insurance Companies, which represents policyholder-owned carriers. “They certainly don’t have the resources to respond to federal regulatory calls.”
A national regulator may coordinate agreements with counterparts in other countries. “It will create a single voice in the U.S. for insurance issues,” Lloyd’s of London CEO Richard Ward said in a June 22 interview. –Sarah Frier
Frank-Dodd Act is a new law promoting financial stability through improvement of financial system. These were created to protect individual tax payer by ending bailouts and other abusive financial services system. It such a great help for every citizen since there is a law that can protect their assets and other financial status. Resource for this article: Citigroup pushing record number of credit card offers via mail