Financial Reform Bill

All the focus this week is on two issues surrounding the financial industry – Obama’s efforts to push his financial regulatory reform bill through Congress, and the fraud lawsuit brought against Goldman Sachs by the SEC. While these two issues should be unrelated, it’s hard to overlook the convenient timing of the SEC’s accusation against Goldman. But since our President has assured us that he found out about the accusations from the news media, and that the SEC is an independent agency that does not report to the White House (and we know politicians always tell the whole truth), we can chalk it up to “coincidence.” And since I already discussed at length the charges being brought against Goldman and the likely effect on the company and stock market, I will spend more time focusing on the impending financial reform bill.

The financial regulatory debate has parallels with the recent healthcare issue. While most people understand why Washington is trying to implement these reforms, much like the healthcare reform bill, few people understand what reforms they are advocating, and how these reforms will affect Wall Street or anyone else. Additionally, both parties are taking such a strong stance on this issue that the facts have become secondary to partisan jabbing, leaving the American people clueless.

The goal of all the proposed reforms fall under four major categories: protecting individuals from banks and other large financial institutions, protecting these institutions from themselves, increasing the power of shareholders, and requiring more disclosure by financial institutions. The strongest opposition from Wall Street has been in response to the idea of a tax that would affect bank, thrift and insurance companies with more than $50 billion in assets, in order for the government to recoup its losses from the bailout. While this would generate more cash flow for the government, it would almost certainly lead to increased fees for these institutions’ clients. The law also seeks to heavily regulate the trading of derivatives, financial instruments whose value is dependent upon the price of an underlying asset. But too much regulation of derivatives could impede the ability of financial institutions and others to hedge against major losses (the intended purpose of derivatives trading). Other proposals include increased shareholder powers, a consumer protection agency, and the Volcker Rule which would require banks to be separate entities from hedge funds or private equity funds, and would also ban proprietary trading by banks except in certain cases.

Any future changes to our country’s financial industry will undoubtedly come with one major caveat – people will find a way around them. Congress needs to limit changes to things that have a high likelihood of achieving the above four goals without unpleasant side effects. Delaying full commissions for mortgage brokers until the loans have been refinanced or shown to be performing, and requiring banks to retain a stake in loans they securitize so that they remain on the hook for some of the losses, are both ideas that would provide positive incentives to do good while increasing accountability by financial institutions. These are the types of changes that might actually prevent another financial crisis. We could do without regulations that just create loopholes, encourage gaming the system and cause more distress to the American taxpayer.