Law Remakes U.S. Financial Landscape

The Wall Street Journal (Link) - Damian Paletta & Aaron Lucchetti (July 16, 2010)

Congress approved a rewrite of rules touching every corner of finance, from ATM cards to Wall Street traders, in the biggest expansion of government power over banking and markets since the Depression.

The bill, to be signed into law soon by President Barack Obama, marks a potential sea change for the financial-services industry. Financial titans such as J.P. Morgan Chase & Co., Goldman Sachs Group Inc. and Bank of America Corp. may be forced to make changes in most parts of their business, from debit cards to the ability to invest in hedge funds.

The Senate passed the bill 60-39 Thursday, following House passage last month. Earlier in the day, three northeastern Republicans joined with Democrats to block a filibuster, allowing the bill to squeak through.

Now, the legislation hands off to 10 regulatory agencies the discretion to write hundreds of new rules governing finance. Rather than the bill itself, it will be this process�accompanied by a lobbying blitz from banks�that will determine the precise contours of this new landscape, how strict the new regulations will be and whether they succeed in their purpose. The decisions will be made by officials from new agencies, obscure agencies and, in some cases, agencies like the Federal Reserve that faced criticism in the run-up to the crisis.

The Commodity Futures Trading Commission has designated 30 �team leaders� to begin implementing its expansive new authority over derivatives, and has asked for $45 million for new staff. The Federal Reserve, Federal Deposit Insurance Corp. and Securities and Exchange Commission are also in the thick of the implementation.

J.P. Morgan Chase, one of the biggest U.S. banks by assets, has assigned more than 100 teams to examine the legislation.

Democrats say the bill will cut the odds of another crisis and better handle one when it arrives. They also contend it will restore confidence in U.S. financial markets, protect consumers and spur growth. White House officials said it will put an end to taxpayer-funded bailouts of banks, addressing the scars of the financial crisis of 2008.

The legislation creates a council of regulators to monitor economic risks; establishes a new agency to police consumer financial products; and sets new standards for the way derivatives are traded. �These reforms will benefit the prudent and constrain the imprudent,� Treasury Secretary Timothy Geithner said in a press conference. �Strong banks, the well-managed financial innovators, will adapt and thrive under the new rules of the road.�

Republicans said the bill could jeopardize the recovery by constraining credit and crimping the banking industry, and chided the expansion of government power it envisions.

The bill �is a 2,300-page legislative monster�that expands the scope and the powers of ineffective bureaucracies,� said Sen. Richard Shelby (R., Ala.).

The measure is the latest sweeping law to emerge from the 111th Congress. But the financial revamp, the 2009 stimulus act and this year�s health-care overhaul�by any measure significant legislative achievements�haven�t translated into support for the White House. Mr. Obama�s approval ratings have sunk to some of their lowest levels in some polls amid a gloomy economic picture and rising doubts that his economic policies are working.

Once this bill is signed into law, lawmakers and the Obama administration are expected to pivot to another contentious issue: the future of government-run mortgage-finance giants Fannie Mae and Freddie Mac. Republicans like Sen. Mitch McConnell (R., Ky.) complain that the failure to tackle these companies in the finance bill was a glaring omission. The administration has begun work on a proposal to redesign the mortgage-finance system, and Congress could take up the issue in 2011.

The finance overhaul will be implemented in a volatile environment. Profits on Wall Street are soaring, with J.P. Morgan reporting $4.8 billion in net profit in the second quarter. But the banking sector is contracting, with close to 300 banks failing since January 2008. Many businesses and borrowers are struggling to obtain loans.

Supporters and critics agree the impact of the bill will be determined over several years.

The law�s passing �is the beginning of the process and not the end,� says Satish Kini, co-chair of the banking group at law firm Debevoise & Plimpton LLP. �The shape of the reform won�t be known until the regulators have spoken.�

Treasury Department officials have taken initial steps to prepare the new consumer agency, called the Bureau of Consumer Financial Protection and housed within the Federal Reserve. Regulators are in the process of creating a system so that large, complex and failing financial companies can be broken up and liquidated without disrupting markets.

Despite creating the new consumer watchdog, the bill leaves America�s patchwork regulatory framework largely intact, and most of the players will be familiar. That has irked critics on the left and right who say one of the bill�s key flaws is that it relies on the judgment of officials rather than hard rules.

Conservatives worry regulators will throttle the industry. Liberals worry they�ll be co-opted by banking lobbyists.

�The same regulators who ignored consumer advocates� warnings about predatory lending have veto power over the consumer agency,� said John Taylor, chief executive of the National Community Reinvestment Coalition. �That club of regulators is very insular, and usually in agreement.�

In a sign of the challenge, at a congressional hearing Thursday to approve her nomination as Fed vice chairman, Janet Yellen acknowledged that the Fed�s regulatory approach was insufficient for years.

�We failed completely to understand the complexity of what the impact of the national decline in housing prices would be in the financial system,� said Ms. Yellen, currently president of the Federal Reserve Bank of San Francisco. �We saw a number of different things, and we failed to connect the dots.�

Regulators will have multiple questions to answer. What types of trades can banks conduct, and what types will be illegal? At what level should regulators cap the fees that retailers pay to banks to process debit-card transactions? On which companies will the Fed apply stricter regulations? What will be the new standards for mortgages, credit cards and ATM fees?

By next summer, regulators could have many answers. The new consumer agency should be established, with its own staff and director. A new council of regulators will be monitoring emerging risks to the economy. There will be new rules on golden parachutes for employees at public companies, policies for ATM cards, the abolishment of the Office of Thrift Supervision, new derivatives rules and hedge-fund registration.
Administration officials and lawmakers have been talking about who should head the new consumer agency, as well as whom to appoint as chief regulator for national banks.

Bank outreach to regulators began in earnest months ago. French bank BNP Paribas hosted a dinner at Manhattan�s Le Bernadin at which representatives from U.S. hedge funds and investment firms grilled a Federal Reserve Bank of New York official about how the derivatives rules would be applied.

Over striped-bass tartare, some participants told Patricia Mosser, the Fed official attending, that they didn�t want much to change in the current model of derivatives trading.

Ms. Mosser said pushing more derivatives onto exchanges, as the law demands, would make the market more transparent and safer, people familiar with the matter said. Still, it was clear the rules wouldn�t be put in place overnight. The law would take months, maybe years, to implement, Ms. Mosser told the group.