Friday, April 30, 2010

The frightening financial reform bill

A thoughtful and constructive financial reform bill is needed. What's now in the works as it has evolved can no longer be described in that way.

In an April 21st post here the misguided measure requiring the spin-off of derivatives businesses from major institutions was discussed. That remains intact in the bill as drafted 11 days ago, two pages in what has become a 1588 page document at last count. If it stays as is, these two pages will have a huge impact on the structure of our financial industry and the U.S. position in the global market. There have been no hearings on this measure and no studies of its impact by any supervisory agency. The Fed is apparently against it, the White House financial staff as well, but Congress has not yet touched it. Could this actually be passed.

In a bill this extensive no one really has a comprehensive grasp of what is in it and what the impact of all aspects will be. As an example, in the jobs bill passed two months ago, Senator Carl Levin and his staff had a short insert that requires any bank worldwide that has accounts of expatriate Americans to report in detail all inflows into those accounts or the account owner would face a 30% withholding tax on any transfer(this information and detailed follow up courtesy of a friend who chose to retire overseas). What makes sense perhaps as a rule applied to the extremely wealthy class that has used tax havens to hide money is simple harassment for many ex-military, ex-overseas corporate, or social security recipients looking for an affordable lifestyle in Costa Rica, Panama, southeast Asia, or wherever. Foreign retail banks will generally be unable or unwilling to comply with the onerous documentation requirements, so many expats are looking at life ahead with no banking services and wondering how that will work. No one saw this coming and it was likely rubber stamped by a congressional committee and passed without any substantive discussion. Since the jobs bill was obviously not a financial services bill, God knows what "gems" of dysfunction are hidden in 1558 pages of financial reform.

With that example of what can happen, here are two more items that are in the bill currently and not widely known.

First, any financial firm selling derivative products to municipal, pension, and retirement plan funds will be required to have a fiduciary duty related to the performance of that derivative. Plain vanilla hedging of bond sale proceeds, future payment obligations, or future income streams is a useful tool, but as in all hedging the outcome will not always be profitable. If the fiduciary duty is mandated that means that any derivative that does not function exactly as planned will be the responsibility of the financial firm that sold it. If passed, that could essentially be the end of any availability of these products to municipal entities, pension funds, and retirement funds except at extraordinary cost. How else could a provider price a derivative that has no downside for the buyer who chooses to take the risk implied in the transaction.

Second, as currently written there will be a national consumer financial protection agency, the overall scope of which is unknown. This could be a constructive agency if it does not become a competitor with other regulators and does not become another unwieldy bureaucracy. The bill also currently allows each state to set their own consumer protection rules above and beyond the national regulator such that states could dictate rules for national banks, something which has never explicitly been done. Providers of credit cards, mortgages, auto loans, and consumer finance may well need some clear limits and supervision at a national level, but if all 50 states add their own rules as well the efficiency of delivery becomes much more expensive. States that get extreme in their regulation would simply find that their citizens have little access to credit. Consumer finance providers in general would become much more conservative due to the fear of retroactive regulation in multiple jurisdictions. This would be chaos, and it could limit the availability of consumer credit broadly.

Admit it, most of us, myself obviously included, know very little about what this bill might contain. Every time I learn more I get frightened. Too many rules impairing the availability of credit, the use of mostly constructive financial tools, and leading to the diminishment of the U.S. as a world financial center could push us right back down to where we were 18 months ago, or worse.


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