Congress Approves Sweeping Financial Regulation Bill

Here's a brief summary of the good and bad that may result from its major provisions.

The Senate's final vote for the new financial regulation bill passed Thursday afternoon as it approved the conference report. With the House passing the measure a few weeks ago, the effort in Congress is all wrapped up. The bill will shortly find itself on President Obama's desk, where he is eager to sign the legislation and make law the most aggressive new regulation the financial industry has seen since the aftermath of the Great Depression.

The vote wasn't exactly a bipartisan story. It narrowly escaped filibuster, as it had precisely the 60 votes needed for cloture. Just three Republicans voted in favor, including Scott Brown (MA), Olympia Snowe (ME), and Susan Collins (ME). One Democrat, Russell Feingold (WI) voted against, not believing the legislation went far enough.

While it's hard to summarize a 2,300-page bill of complicated new regulation, here are some of the big highlights along with positives and negatives that could result from each:

Systemic Risk Council: The bill establishes a systemic risk council consisting of the chairs of major financial regulators. It hopes to spot looming financial risks and take action to prevent potential crises before they strike.
The Good: If the council's foresight, cooperation, and actions prove successful, it could preempt future economic catastrophes.
The Bad: Some people are skeptical that the group will manage to spot growing problems or have the audacity to stop them before they strike.

Non-Bank Resolution Authority: The legislation provides the council the ability to recommend that the FDIC wind down large non-bank financial firms when they run into trouble. The intent is to prevent future bailouts, while ensuring that big firms can fail without causing a huge market shock.
The Good: If the resolution plans that firms create do the trick, then the government won't need future bailouts to maintain economic stability when giant firms fail.
The Bad: The big institutions that are subject to this regulator could have a competitive advantage over others, since their creditors might feel they'll be treated better than in bankruptcy court if these firms fail.

Consumer Financial Protection Bureau: A new regulator will have the power to ensure that consumers are treated fairly by banks and finance companies.
The Good: Until now, there has been no regulator with the sole purpose of acting as an advocate for consumers. It should crack down on predatory lending and improve disclosure.
The Bad: New regulations could cause banks to deny credit to some consumers on the margins and make it more expensive for everyone else. The bill also has some exemptions, including auto dealers, which will put some loans out of the bureau's reach.*

Derivatives Rules: The bill would require most derivatives to be cleared and put on exchanges. It would also forbid banks to market certain types of derivatives unless they create a separately capitalized subsidiary.
The Good: More derivatives cleared should be good for financial stability. More on exchanges could improve transparency.
The Bad: Derivatives will likely become more expensive, as smaller players might be subject to collateral calls to qualify for clearing. There's also some concern that clearing houses could become too big to fail. Additionally, discouraging banks from marketing some derivatives could make them even riskier.

Volcker Rule: Although no provision would require banks to shrink, there is a rule that would limit their proprietary trading (to 3% of tier 1 capital), the profits from which help them to grow. It also limits their ownership (to a 3% stake) in any hedge fund or private equity endeavor.
The Good: This puts a ceiling how much bank can trade for their own book, which some believe is a risky activity.
The Bad: The ceiling is rather high, so few banks will have to change their trading strategies very much. Those hedge funds and private equity endeavors might have been better off with banks having additional skin in the game.

Securitization: Since toxic securities created from mortgages were a big problem during the financial crisis, the bill demands that banks have 5% skin in the game for any loans they attempt to pool and slice into bonds to sell to investors.
The Good: Banks may enhance their loan standards since they have to eat some of what they cook up.
The Bad: This will likely shrink lending capacity, since securitization will become more expensive and cumbersome for banks.

Rating Agencies: The companies that rate bonds will have additional SEC oversight and be subject to additional regulatory standards.
The Good: This could help ensure more prudent and conservative ratings.
The Bad: The measures may not go far enough, as the SEC must take action to create new mechanisms that would end the conflict-of-interest that currently exists between accurate ratings and making bankers happy.

So what isn't the bill doing? Here are some of the significant misses:

Capital Requirements: Although the legislation urges the new systemic risk council to establish higher capital requirements for banks, a specific new floor is not provided.
Leverage: The House bill would have limited bank leverage to 15 to one. The final bill does not. So unless the systemic risk council decides to impose such a requirement, the culture of high bank leverage will continue.
No Break Ups: Many believe that part of the systemic risk problem was created by allowing financial institutions to grow too large. This bill wouldn't explicitly require any to be broken up, though the council may be able to do so under certain circumstances.
GSEs: Fannie Mae and Freddie Mac are largely considered a major cause of the housing bubble and are the biggest of bailout recipients. Yet the bill does not create new rules or changes for these firms.

* I was contacted by the National Automobile Dealers Association, who didn't like this point. They explain that all auto loans will still be under the jurisdiction of the new bureau. It's only dealers who might assist in loans, but do not originate them directly, that will lie beyond its reach. There's a fine line here. The dealership can remain exempt even if it assists. It just can't fund, underwrite, or service the loans. Hopefully this will do the trick, though it's a little unclear why this exclusion was fought for so hard if auto loans are truly unaffected by it.