Billed as the most sweeping financial reform since the 1930s, Congress has sent President Barack Obama a massive 2,300-page bill intended to prevent a repeat of the 2008 financial crisis.
Yet even before it becomes law, critics are warning that key provisions of the measure may fall short of what they were supposed to accomplish.
“I would say that nothing in this bill would have prevented the previous crisis — the one we are working our way through right now,” said William Isaac, former chairman of the Federal Deposit Insurance Corp. "And it clearly won't prevent the next crisis."
The law sets broad guidelines for the existing patchwork of regulators — including the Federal Reserve, Securities and Exchange Commission and Commodity Futures Trading Commission — and establishes bodies to oversee consumer protection and monitor “systemic risk.”
Those regulators have been tasked with writing the specific rules of the road governing limits on risk-taking by financial firms and previously unregulated trading. Other provisions are supposed to make it easier to liquidate large institutions that pose a risk to broader financial system. A new consumer protection bureau is supposed to guard against lending abuses.
But it will take years before the impact of the law is known. That’s because most of the specific regulations have yet to be written.
“The devil is in the details: There are a lot of unanswered question that were thrown to regulators," said Jay Brown, a professor of corporate and securities law at the University of Denver. “The reason it was thrown to regulators is because there are no answers. So for example: What’s too big to fail? Nobody knows the answer to that.”
The new law is being hailed as being “tough on Wall Street.” But its passage is just the start of what is likely to be a hard-fought battle over the regulation of specific practices that nearly sank the global financial system.
"Unless your business model depends on cutting corners or bilking your customers, you have nothing to fear," Obama said after the vote. He said he will sign the bill next week.
By leaving so much to the discretion of existing regulators, the new law is “a boon to Wall Street lobbyists, who will now be working behind the scenes to influence the regulators,” according to John Taylor, president & CEO of the National Community Reinvestment Coalition.
“This is what happens when you allow the very industry that caused the problem to buy all the front-row seats at the bargaining table,” he said.
Other critics of the measure argue that regulators — not regulations — were the major cause of the financial meltdown.
The wave of predatory lending that sank the housing market, for example, could have been largely prevented if the Federal Reserve had enforced existing rules on mortgage lending, according to Cornelius Hurley, director of the Morin Center for Banking and Financial Law at Boston University.
“You can point the finger at one person who dropped the ball and that was Alan Greenspan,” he said. “So the antidote to that is to ensure that an Alan Greenspan never happens again.”
Under the new law, banks and other financial institutions will be overseen by a council of regulators. That group will be charged with identifying the kinds of “systemic” risks that spun out of control in the collapse of Bear Stearns and Lehman Bros. in the financial panic of September 2008.
But there’s little to be gained by entrusting that task to the same regulators who failed to spot the causes of the panic the first time, said Isaac, the former FDIC head.
“If a bank went to the regulators and said, ‘We’ve got a good idea: we’re going to put our lending officers in charge of risk management,’ that bank would be put out of its misery immediately,” said Isaac. “That’s what the government just did. It put the regulators in charge of assessing their own performance. It’s a very bad system.”
The new law also sets up different rules for big banks — those with more than $10 billion in assets — and the rest of the industry. That means a handful of banks will continue to enjoy “too big to fail” status – complete with an implicit government guarantee that lowers their borrowing costs and gives then a competitive edge, according to Hurley.
“It enshrines for the foreseeable future that there are two parts of the financial system,” he said. “There are the six largest banks, which account for about 60 percent of the financial system, and then there is everybody else, from regional banks down to credit unions. The top six get a subsidy in the form of lower borrowing costs. And everybody else pays for it.”
The new law is also supposed to protect consumers from predatory lending and excessive bank fees. Backers of the newly authorized Consumer Financial Protection Board argued that existing regulators can’t keep consumer interests foremost if they are also charged with protecting the “safety and soundness” of the financial system.
While the law creates a separate agency with a single consumer mandate, it remains beholden to those regulators, who retain the power to veto its regulations and enforcement actions. That setup, said Taylor, could seriously hamper the board’s effectiveness.
“That club of regulators is very insular, and usually in agreement,” he said. “They can kill serious reform, and the financial lobby remains much more influential with regulators than consumer advocates."
It’s also not clear how the industry will respond to tougher new consumer protections once they are written. Efforts to restrict one set of bank fees, for example, could simply shift those consumer costs to another form of revenues for banks. If fee restrictions make some customers unprofitable, they may see their accounts canceled, according to Richard Bove, a bank industry anlayst at Rochdale Securiteis.
“My guess is there will be at least 10 million people who lose their bank accounts in the United States over the next 12 months, and they will not get banking services,” he said. “Which means that they will have to use payday loans, they'll have to use Western Union payment services, they'll have to use a series of other methods of handling their banking because they won't be profitable for banks and the banks won't keep them.”
Under the new law, banks that face higher capital requirements — designed to provide a greater cushion against bad loans — will have less money to lend. That could make it more difficult for businesses to borrow while the economy is struggling to get back on its feet.
Tighter lending regulations will also make it harder to get a mortgage, according to Howard Glaser, a mortgage industry consultant who served the Department of Housing and Urban Development in the Clinton administration.
“Consumers will see ‘safer’ mortgages, but fewer of them will qualify,” he said. “They will have fewer choices of mortgage lenders as the concentration of mortgage lending by a few big banks accelerates.”