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The Impact of Financial Reform
by   Mark Wade  

The Financial Reform Bill was crafted largely as a reaction to the banking-sector meltdown of 2008, which is why many of its provisions are aimed directly at big banks and other major financial institutions. But there are also provisions that will affect the individual investor as well. And of course, the banking restrictions’ ability to prevent another crisis will ultimately impact all of our financial lives.

Here’s a thumbnail guide to how your financial goals might be touched by the financial reform bill:

Consumer Protection There will be a Consumer Financial Protection Bureau under the control of the Federal Reserve, although the director is technically independent. This bureau would have the right to create new rules for consumer financial products like mortgages, credit cards, payday lenders and check cashing businesses.

Mortgage Regulations The bill imposes many new regulations on mortgages, which were of course seen as a prime culprit of the banking crisis. The primary purpose here is to force lenders to be more responsible in issuing mortgages, but the upshot is that many of the rules have become kinder to borrowers as well. Origination fees, for example, will now generally be limited to three percent of the loan. In the past, many lenders would issue documents estimating the origination fee as zero to 5 percent – and it would almost inevitably go to 5 percent. Banks also will not be able to easily charge prepayment fees on people who pay back more than their regular loan amount each month. Bonuses for lenders who push borrowers into higher-priced loans have also been prohibited.

Perhaps more significantly, mortgage lenders will now be required to keep 5 percent of each mortgage they issue. In the past, lenders would sell off the entirety of these mortgages to outside investors, meaning the lender itself had little interest in whether the loan would be repaid. By forcing mortgage lenders to keep some skin in the game, they will be less willing to issue so many reckless mortgages that don’t have high expectations of being repaid. (Loans to high-quality borrowers are exempt from this rule.)

Debit Cards The Fed has been empowered to set a "reasonable and proportional" fee that banks charge can businesses for processing debit card transactions. Banks now charge 1 to 2 percent for these transactions, leading many retailers to mark up their prices to cover the added expense, or else require a minimum purchase on debit cards. That may not sound like a lot, but it’s 2 cents on every dollar you spend with a debit card, for a total of $48 billion a year. Of course, there’s no guarantee that retailers would drop their prices once the debit-card fees are lowered. One thing that is likely to happen, though, is that more retailers will begin to accept debit cards.

The Volcker Rule This rule, intended to keep banks from gambling in risky investments with taxpayer-insured depositors’ funds, survived in a somewhat weakened form from what was originally announced. Banks are prohibited from investing depositors' taxpayer-insured money in proprietary trading schemes, but they are still able to invest up to three percent of what's known as tier I capital – which consists of all a bank’s common stock and reserves, or most of its assets - in private equity and hedge funds. One estimate holds that Goldman Sachs will have to reduce its investments by $10 billion to comply with the rule, and Morgan Stanley by $3 billion. They have ten years to get their investments down to that level.

Resolution Authority Should huge financial institutions find themselves bordering on a meltdown once again, the bill provides for the Treasury Department to have management authority over the proceedings, including the power to pay for it with an assessment on other banks. The idea is that the crisis could be unwound in a stable, orderly fashion without the need for bankruptcy. It remains to be seen how useful this will be in a crisis, but Henry Paulson, the Bush Administration treasury secretary who presided over the Lehman Brothers bankruptcy, has said these powers would have been of great help in dealing with the Lehman situation.

Derivatives The law cut back on the types of derivatives banks are allowed to invest in, but they are still permitted to put assets into interest-rate swaps, foreign exchange swaps, and gold and silver swaps to remain. All told, that means that roughly $500 trillion out of the $615 trillion over-the-counter derivatives market is still free and clear.

What’s Missing? The biggest oversight is probably that there’s no provision for dealing with Fannie Mae and Freddie Mac, which have now cost the taxpayers about $145 billion in bailout money. These two quasi-government organizations are now under federal receivership, and the end for them is not in sight. The failures of the ratings agencies have also been kicked down the road; although the bill has some language about this, it basically just forms a commission to study the problem.

One particularly unfortunate example of this is that the decision as to whether to force brokers to follow a fiduciary standard - to be required to always put their clients' needs ahead of their own - was put off until there could be further study on the issue from the SEC. This is unfortunate. Wealth managers such as myself are pledged to follow their fiduciary duty, and brokers should too.

And there is plenty yet to be written, since so many of the bill’s provisions simply call for regulators to formulate new sets of rules. It will be years, if not decades, before we can assess the full impact of this legislation. But we’d be happy to consult with you on what immediate changes it might make to your ability to meet your financial goals. To talk about how financial reform affects your financial life, send me an email at, or give me a call at 908-647-6000.


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