Financial Reform Passed, Now What?

Once Washington's euphoria wears off, the regulation will begin.

For those who had been fighting for financial regulation in Congress, today feels a little anticlimactic. The bill is now just awaiting President Obama's signature, but the world hasn't actually changed yet. Despite the bill's many new provisions, regulations take time to be put in place. So the market won't really feel its full effect for some time. Here's how things will evolve.

New Regulators Get Set Up

The new legislation sets up a number of pretty significant new regulatory powers for the government. It creates a consumer financial protection bureau, a systemic risk council, and a non-bank resolution authority, to name a few of the big ones. These new regulators can't do any rulemaking until they've got their staffs in order and have taken care of other logistics. This won't happen overnight, but it shouldn't take very long.

Regulators Interpret Law

Once the regulators are ready to roll, they've got a lot of interpreting to do and decisions to make. The new bill actually provides few details about the new rules that banks and other financial firms will face. Most of that discretion is left up to the regulators. For example, it directs the new council to raise capital requirements, but doesn't tell it by how much. A lot of this will require studies and/or feedback from the industry and other experts before rules can be put into effect. Even though the bill is done, a lot of uncertainty remains for financial firms.

Financial Industry Shifts Strategy to Cope

As the new rules begin to be better understood, firms must change their strategy accordingly. For example, the bill says banks can no longer own more than 3% of a hedge fund. If they currently do, they'll have to figure out how to divest, without a major impact to their profits. Similarly, as the new consumer bureau sets rules for credit, banks and finance companies will also change how they lend. You can think back to how such firms responded to new credit card rules passed in the spring of 2009 by tightening credit and raising rates.

Financial Industry Find Workarounds

Once these firms fully understand the rules, they can begin devising ways to keep their profits up, despite the changes. Skeptics of regulation efforts believe that Wall Street will find loopholes to wiggle out of changes Washington imposes on their industry. If they're right, firms have already begun trying to determine how to keep their business as little affected by the regulation as possible. Eventually the cycle will likely repeat, where the government imposes more regulation in response to those tactics.

Although the bill is done, the market probably won't feel the full effects for some time. Even if financial firms do manage to dodge some of the changes, they will only be able to do so by shifting their strategies in some ways. We won't know how well the bill accomplishes its chief goal -- financial stability -- until another crisis hits. Here's hoping it won't need to be put to the test for a while.