US Financial Market Regulation: Reform Overview

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Overview of proposed and actual reforms to U.S. financial market regulation in recent years.

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  • Since January 2009, financial services firms have spent nearly $600 million and hired hundreds of lobbyists to influence the debate, according to the Center for Responsive Politics.Liberto, Jennifer (2010, May 21). Senate Passes Sweeping Wall St Reform. CNN Money. Money.cnn.com
  • Dodd, Chris (2010, June 10). Dodd Statement on Wall Street Reform. United States Senate Committee on banking, Housing, & Urban Affairs. banking.senate.gov
  • April 2010Republicans attacked the bill because of $50 B fundThe fund would be raised from bank fees and would be used to shut down failing institutionsShelby, the ranking Republican on the banking committee, could not get a concession from Dodd, the senator pushing the billEventually the filibuster was droppedMayShelby and Dodd agree that the FDIC would finance the liquidation of failed companies using Treasury credit backed by the companies assetsThis credit would be recouped in sales, with shareholders and creditors losing outConflicts remain over the spin-off of derivativesTimes Topics (2010, June 15). Financial Regulatory Reform. The New York Times. Topics.nytimes.com
  • Components
  • Obama: Create more accountability Need to set clear regulations so everybody meets certain standards House: Oversight board 11 member council Purpose is to monitor the financial market, detect threats before they threaten the economy and enforce tougher regulation Senate: Financial Stability Oversight Council 9 expert members Including Treasury secretary, Federal Reserve chairman, insurance expert, and heads of regulatory agencies and the consumer protection bureauSimilar purpose
  • Currently there are 7 different Federal agencies that write and enforce rules protecting consumers The agencies are: Federal Reserve, FDIC (Federal Deposit Insurance Corporation) National Credit Union, Federal Trade Commission Office of the Comptroller of the Currency Office of Thrift Supervision and The Department of Housing and Urban Development The problem is that consumer protection is not the top priority for these organizations Consider the department of housing… Because of this, a large part of consumer financial services operates without any real oversight One writer says, “The financial meltdown of 2008 was essentially a consumer-protection meltdown, a direct result of exploitative loans that never should have been approved”Grunwald, Michael (2010, Feb 17). The Case for a Consumer Financial Protection Agency. Time. Retrieved from time.com-------------------------------------------------------------------------------------------------------------------------------------------------- Obama -> In his outline for financial reform said we needed to establish strong consumer protection with one agency He said, “America needs one independent consumer financial protection agency with a clear mission: to prevent abusive and deceptive practices and to promote transparency and consumer choice” A SINGLE agency to improve accountability and transparency An INDEPENDENT agency to regulate financial services without conflicts of interest An agency with a MISSION to increase transparency about the costs and risk of consumer creditE.g. credit card rates It will also be a lean agency, it’s not taking money away from tax payers The maximum budget will be ¼ of the combined budgets of the SEC and FINRA Or, approximately 2% of the amount paid in credit card penalty fees last year http://www.financialstability.gov/roadtostability/regulatoryreform.html - Fact Sheet: An Agency for Consumer Financial Protection-------------------------------------------------------------------------------------------------------------------------------------------------- It seems pretty straightforward right? It’s a good idea to make sure consumers are not being deceived Yet, this is some of the most highly contested part of Financial Reform Legislation
  • House and Senate see 2 different optionsBoth want an agency that will curb unfair practice in consumer loans and credit cards, but… House wants a consumer protection agency that stands on its own This way there are no conflicts of interest etc However, it will not regulate the auto industry More specifically, there is a loophole for auto loans That seems kind of strange considering the many problems in this industry Senate wants the create a Consumer Protection Bureau that would fall under the Federal Reserve and receive its budget from the Federal Reserve Board Despite being under the Fed, it would still autonomously write rules for consumer protection Also, it would be led by an Independent director appoint by the President and confirmed by the Senate Some interesting provisions in the Senate bill are that: The Bureau would have to write “model disclosures” for companies to see Companies would then be given incentives to follow the disclosure models The Bureau would also crack down on penalties for paying mortgages early Also, the Bureau would not only prevent consumer deception, but also educate consumers It would be in charge of creating an Office of Financial Literacy and running a consumer hotline to answer questions Can’t we combine the House and Senate versions Create a consumer protection agency with broader authority (per the Senate) but make it a free-standing regulator (per the House)
  • There are lots of questions about all the loans the Federal Reserve gave out during the financial crisis There needs to be more transparency in the Fed’s actions House proposes to tighten limits on the Federal Reserve It would no longer regulate consumer protection And it would no longer be omnipotent There would be a limit on its authority to create new regulations and make emergency loansAlso, the Government Accountability Office would have more power to audit the Fed’s activitiesSenate proposes that the Federal Reserve continue to supervise banks and bank-holding companies Congress can order the GAO to conducta one-time review of the Fed's emergency lending during the financial crisis Overall, a one time audit isn’t really that helpful, we should go with the house proposal that would let us conduct continuous auditsAfter all, don’t we want to know who our taxpayer money is going to
  • Derivatives: Complex products that bet on the future movement of underlying securities You can earn a large return based on a small movement in the price of the underlying asset However, you can lose a large amount if the price of the asset has a significantly negative move Derivative are blamed for accelerating the Wall St crisisAIG and Lehman Brothers fell, in part, because of all their derivates tradingThere were concerns about the company’s ability to pay off their derivatives contracts Combine these fears with a lack of transparency about the underlying risk of the derivate and the market freezes and you have a crisis These problems occurred because there has been no regulation of derivativesThe Derivates Market exploded in recent years from $91 trillion sold in 1998 to $592 trillion sold in 2008 It’s time we made some regulation(Senate Financial reform summary)-------------------------------------------------------------------------------- Obama called for a more transparent derivative market This would make derivates safer and help Main St businesses that use derivates to manage commercial risksHouse wants to regulate derivates with exceptionsBanks can still operate derivatives businessAnd there are exceptions for companies that “use derivatives as a hedge against price fluctuations”(Comparison from Huffington Post) The Senate has a much tougher vision Senate will force banks to spin off their derivatives businesses It bars banks from derivatives trading It would require derivates to be traded in clearinghouses or exchanges This would have a number of benefitsDerivatives trading would be regulated by the SEC and CFTC Regulators would pre-approve derivatives contracts before they could clear Allowing monitoring /oversight of riskUncleared trades would be subject to margin requirements to offset their risk All of this would eliminate the loopholes in derivatives trading Data on derivates would be collected and published There would be an established way to monitor and respond to risk Overall, this method of trading would make the derivatives market much more transparent Houses’ exceptions leave too much room for future problems and don’t really make the derivatives market more transparent They should go with the Senate on this one
  • A problem in the financial market has been banks’ proprietary investments. These are investments in hedge funds and private equity funds that do not benefit clients Obama’s proposed regulation is based on the Volcker Rule Former Federal Reserve Chairman Paul Volcker’s proposal to stop banks from making investments that are not on behalf of clients This affect many banks, like Goldman Sachs, who make a lot of money off proprietary investments The House proposes that proprietary trading be regulated on a per bank basis Speculative trading can be banned if the bank’s activity could threaten the stability of the financial system The Senate proposes rules to limit the size and scope of commercial bank operations. They would be prohibited from speculative trading from their own accounts or with derivatives To regulate this, the Senate also plans to institute clear lines of responsibility In order to streamline supervision of banks and create clarity and accountabilityThe regulatory agencies would be as follows: FDIC: State banks and thrifts with assets <$50B OCC: National banks and federal thrifts <$50BFederal Reserve: Bank and thrift holding companies >$50BThe House does not propose any real limits in the area of proprietary investmentsThe Senate proposal is much more comprehensive and more beneficial to investors but it will also face a lot more opposition from banks
  • I won’t go into too much detail on executive pay, but it’s basically the idea that we have an out of control rewards system for executivesThey are being given incentives for reaching short-term goals and losing sight of long-term goalsObama calls for a reform of executive pay in order to protect shareholdersAnd ultimately their profitsHouse proposes say on pay legislation, where shareholders would be given the right to vote on executive pay packagesThis would give shareholders a voice and the opportunity to hold executives accountable for their actions and performanceAlso, the pay packages would be set by a compensation committee of independent directors The Senate offers a similar proposal with a say on pay process and compensation committee, but with additional clawback provisionsThe clawback provision is the idea that there is no compensation for liesIt would establish a policy to take back executive compensation if that compensation was based on an inaccurate financial statementA clawback sounds like a pretty good idea, shareholders would not only be voting on executive performance, but they could be sure executives were following through on that performance
  • The ratings agencies are supposed to provide in-depth credit analysisYet they failed to warn people aboutrisks during the financial crisisHigh ratings were given to bad mortgage related securitiesConsider the fact that AIG had a AAA credit rating pretty much right up until the point it fell apartUnsafe, asset-backed securities had good ratings Because the ratings agencies had weak oversight, there was a lack of transparency, and they were rife with conflicts of interestThe proposed solutions areThe House want to make ratings agencies register with the SECAnd face increased liability standards for ratings mistakesThe Senate wants to establish a new Office of Credit Rating Agencies that would be created under the SECThis office would be used to strengthen regulation of ratings agenciesAnd it would be an independent board that could select agencies to rate new financial products, eliminating conflict of interests when banks pay ratings agencies to rate their securitiesAnd to evaluate how ratings agencies assess riskThe Senate would also require ratings agencies to disclose their methodologiesMethodologies would become especially important as, under this legislationInvestors would have the right to bring a liability suit against ratings agencies for lack of due diligenceFor knowing or reckless failure to conduct a reasonable investigation (due diligence)Consider the massive failure of ratings agencies, it would probably be better to err on the safe side and go with more legislation
  • Problems arose in the mortgage market because companies made risky investmentsThey gave mortgages to people who couldn’t pay them because they got a fee for making the loanAlso because they could pack them off as securitiesObama’s financial reform calls for the end of abuses in the mortgage market and the house and senate came up with very similar solutions to thisThe House proposes to ban liar loansThis is a loan where the borrow get money without proving they can make the mortgage paymentsWith the new legislation lenders have to obtain proof that borrowers can pay for their loansThe Senate also calls for this proof of future paymentBut it additionally requires firms to retain riskFirms that sell mortgage-backed securities must keep skin in the gameThey must retain at least 5% of the credit riskIt’s definitely a good idea to make sure people can pay their loans and that goes back to consumer protectionAnd, maybe I have a lack of faith in the system, but I don’t think banks will conduct due diligence unless they must retain some of the risk, per the senate legislation
  • We have gone to the rescue of too many big companies, all because they were too big to fail Giant firms seemed to think they deserved a bailoutThey took big risks before and during the financial crisis and taxpayers paid the priceIt’s time to do something about this problemObama calls for reform that will constrain the size of firmsSpecifically, no firm can have more than 10% of the liabilities in the financial systemsFirms that are too big will face liquidation The House’s approach to “too big to fail” mainly focuses on taxpayersIn the instance that a bank does fail, other large banks would be taxed to raise funds to pay off creditorsSo at least the taxpayers wouldn’t foot the billThe Senate’s approach is much more comprehensiveLimits the FedSo it can only make emergency loans to banks that need immediate capital, but are otherwise healthyAlso sets regulation that encourages companies not to grow to bigIt gives regulator the power to break up financial companies that have grown too bigAnd could threaten to destabilize the financial systemAnd it institutes new capital requirements that make it undesirable to get too bigThe approach also outlines a mechanism to unwind failing companiesIt sets a new liquidation process, similar to the FDIC’s (Federal Deposit Insurance Corporation) process for shutting down failing banksIt also requires large companies to submit funeral plansFuneral plans are plans for a rapid and orderly shutdown should a company go underCompanies that fail to submit acceptable plans will face increased capital requirements and growth restrictionsOverall, considering the number of companies that were too big to fail, but did fail… let’s plan for the funeral
  • Capital standardsLarge institutionsSenate defines them as banks with >$250 B in assetsHouse defines them as large bank holding companies that pose a potential risk to the economyHave to meet certain capital requirements to offset riskHedge funds need more transparencyThey are responsible for huge transfers of capital and risk, but many operate outside financial regulationHedge fund advisors would be required to register with the SECThis would increase supervision, allowing us to collect information, judge risk and basically know what’s going onSEC has also fallen short and needs more oversightFinancial reform proposes legislation to reform management of the SECAlso, to form an Investment Advisory committee to serve as an advocate for investorsAnd considering, the failure to listen to warningsAs in the Madoff scandalTo encourage whistleblower to come forward by offering reward of up to 30% of the funds recovered
  • Editorial (2010, June 17). Congress Must Try To Improve Final Wall Street Reform Bill. Boston Globe. Boston.com
  • House is now talking about establishing accountability acrros the boardSpecifically, to include a provision to make brokerages more accountable It would require brokers to sell stocks and bonds in clients’ best interests and disclose all conflicts of interest(Vekshin, Allison (2010, June 16). House Lawmakers Seek Fiduciary Obligation for Brokers. Bloomberg BusinessWeek. Businessweek.com)House also wants to address the cost of SOXIt wants to spare small companies (market value <$75 M) the cost of complying with SOX audit rulesIt also wants to reduce fees to companies from $75-250MThese new ideas and the conflicting parts of the financial overhaul might cause conflict, but we think they can reach the deadlineAfter all, recent crises has shown us that we really need to reform the regulation of financial market
  • Editorial (2010, June 17). Congress Must Try To Improve Final Wall Street Reform Bill. Boston Globe. Boston.com_______________________________“A clear lesson of this crisis is that any strategy that relies on market discipline to compensate for weak regulation and then leaves it to the government to clean up the mess is a strategy for disaster. “ US Treasury Secretary Tim GeithnerGeithner, Timothy (2010, April 13). Op-ed: Financial Reform with Teeth. U.S. Department of the Treasury Press Room. Treas.gov_________________________________BibliographyLiberto, Jennifer (2010, May 21). What’s in the Wall Street Bill. CNN Money. Money.cnn.comFinancial Reform Summary as Filed banking.senate.govhttp://www.financialstability.gov/roadtostability/regulatoryreform.html - Fact Sheet: Top 10 Things You Should Know About Financial ReformCompare Senate, House Financial Reform Bills (2010, May 20). Huffington PostJohnson, Fawn (2010, June 15). A House, Senate Showdown Looms. Wall Street Journal. Online.wsj.comBarney, Frank (2009, December 2). Restoring American Financial Stability Act of 2010. Library of Congress. Thomas.loc.govGraphic (2010, May 20). Major Parts of the Financial Regulation overhaul. Nytimes.com/interactiveSanati, Cyrus (2010, May 25). Senate Names Members of Panel on Financial Bill. The New York Times. Dealbook.blogs.nytimes.com
  • US Financial Market Regulation: Reform Overview

    1. 1. Agenda Comments on reform Reform timeline Financial Market regulation Recommendations Future of reform
    2. 2. Comments on Reform1 year $600 M “When this bill becomes law, the joyride on Wall Street will come to an end”
    3. 3. Revamping FinancialRegulation “The central question that we must address in this bill is how do we restore the faith of the American consumer? The core strength of the American economy is that people have faith in the system. That faith was shattered in this crisis, and we must do our best to bring it back.”
    4. 4. Timeline 2009  June: Obama proposes sweeping reform  December: House bill passed (223-202) 2010  April 12: Republicans attack bill  Filibuster  May 4: Shelby and Dodd deal  May 20: Senate bill passed (59-39)  June 10: Conference committee
    5. 5. Financial Market Regulation Market oversight Consumer protection Federal Reserve Derivatives Bank restrictions Executive pay Ratings agencies Mortgages Companies too big to fail
    6. 6. Oversight: Can we get awarning? Financial Crisis Obama: Call for accountability House: Oversight board Senate: Financial Stability Oversight Council
    7. 7. Financial Market Regulation Oversight Consumer protection Federal Reserve Derivatives Bank restrictions Executive pay Ratings Mortgages Too big to fail
    8. 8. Consumer Protection: Do we need it? “The financial  Overseen by 7 agencies meltdown of 2008 was essentially aconsumer-protection meltdown”  Obama  One independent agency with a mission  Lean ○ Budget = 2% of last year’s credit card penalties
    9. 9. Consumer Protection: Where does itgo? House: Stand alone agency  Does not regulate the auto industry Senate: Bureau under Fed  Autonomous rules  Independent director  Provisions ○ Model disclosures ○ Mortgage oversight ○ Office of Financial Literacy ○ Consumer hotline
    10. 10. Financial Market Regulation Oversight Consumer protection Federal Reserve Derivatives Bank restrictions Executive pay Ratings Mortgages Too big to fail
    11. 11. Federal Reserve: Can I get a loan? Crisis loans House: Tighten limits  GAO audits as needed Senate: Supervisory role  One time GAO audit
    12. 12. Financial Market Regulation Oversight Consumer protection Federal Reserve Derivatives Bank restrictions Executive pay Ratings Mortgages Too big to fail
    13. 13. Derivatives: How much do we regulate? Market boom: $91  $592 trillion  Brought down AIG and Lehman Brothers Obama: Transparent derivatives market House: Regulation with exceptions Senate: Separate derivatives trading  Regulated risk  More transparency
    14. 14. Financial Market Regulation Oversight Consumer protection Federal Reserve Derivatives Bank restrictions Executive pay Ratings Mortgages Too big to fail
    15. 15. Bank Restrictions: Investorsfirst? Proprietary investments Obama: Use the Volcker Rule House: Ban threats to the financial system Senate: Limit size and scope  Clear lines of responsibility ○ FDIC, OCC and Federal Reserve
    16. 16. Financial Market Regulation Oversight Consumer protection Federal Reserve Derivatives Bank restrictions Executive pay Ratings Mortgages Too big to fail
    17. 17. ExecutivePay http://www.thedigeratilife.com/images/executive-pay.jpg
    18. 18. Executive Pay: Do I get asay? Out of control rewards system  Incentives for short-term gains Obama: Reform executive pay House: Say on pay Senate: Say on pay and clawbacks
    19. 19. Financial Market Regulation Oversight Consumer protection Federal Reserve Derivatives Bank restrictions Executive pay Ratings Mortgages Too big to fail
    20. 20. Ratings: Who deservesAAA? No crisis warnings  AIG’s AAA credit rating House: Register with SEC Senate: Office of Credit Rating Agencies  Disclosure of methodologies  Investor liability suits
    21. 21. Financial Market Regulation Oversight Consumer protection Federal Reserve Derivatives Bank restrictions Executive pay Ratings Mortgages Too big to fail
    22. 22. Mortgages: How much do youmake? Risky mortgages for fees Obama: Stop abuses in mortgage market House: Ban liar loans Senate: Ban liar loans  Keep skin in the game
    23. 23. Financial Market Regulation Oversight Consumer protection Federal Reserve Derivatives Bank restrictions Executive pay Ratings Mortgages Too big to fail
    24. 24. Too Big to Fail: Or not?  Too big does fail  Obama: Size constraints  House: Bank tax  Senate: Unwinding  Limit Fed loans  Increased regulation  FDIC liquidation procedure  Funeral plans
    25. 25. Financial Market Regulation Oversight Consumer protection Federal Reserve Derivatives Bank restrictions Executive pay Ratings Mortgages Too big to fail
    26. 26. Other regulations  Capital standards  Capital to offset risk  Hedge fund transparency  Registration  Increase oversight of SEC  Encourage whistleblowers
    27. 27. Recommendations 1- Independent consumer protection agency 2- No regulatory exemptions  Banks assets <$10 B = 95% of banks 3- Close loopholes  Volcker rule 4- Register derivatives 5- Hold capital to cover losses
    28. 28. Conference: Senate + House =? Status  June 10 ○ House and Senate reps in Conference  July 4 ○ Revamped bill due to President Obama Future conflicts  Broker accountability  SOX compliance in small companies
    29. 29. Conclusion“If Americans can have regulations to protect their water, their meat, and their baby toys, they should not be denied the strictest possible regulation to protect their money.”

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