6/25/2010
By David Silver, Research Analyst

More Articles by David Silver

After an all night argument/meeting, the Democrats came to an agreement that hopefully will make financial regulation a reality.  I say hopefully because the uncertainty and the back and forth of members of Congress have caused the market a good deal of anxiety.  There has been a push from Main Street to beat those nasty bankers and Wall Streeter's down, but this plan will probably have many unintended consequences.  Representative Jeb Hensarling (R – TX) said, "my guess is there are three unintended consequences on every page of this bill." The bill has almost 2,000 pages.  So let's take a look at what the bill is expected to do and what the potential ramifications will be for Main Street.  

One of the most important aspects of this bit of legislation is its hope that it will get rid of the too big to fail mentality.  While it failed really to address that problem, it did implement ways that government can systematically dismantle a failing firm.  Over the past 18 months, the failure and absorption of these failed banks has only increased the too big to fail perception.  The top 11 banks in terms of deposits (according to the FDIC) have more deposits in aggregate than the remaining 7,930 banks under the FDIC's purview.  The chart below shows the top 15 banks in terms of deposits.  Remember that J.P Morgan Chase (JPM) absorbed Washington Mutual and Wells Fargo (WFC) beat out Citigroup (C) for Wachovia.  The legislation did force the financial companies to have more capital on hand and to restrict the types, and amount, of risk it can engage in.   

Alright, so it didn't fix the too big to fail problem, let's look at what it did accomplish.  Lawmakers agreed to the "Volcker Rule", named after former Federal Reserve Chairman Paul Volcker, which prohibits banks from making risky bets with their own funds.  As a compromise, the bill is expected to allow financial companies to make limited investments in areas such as hedge funds and private equity funds.  The move could require some big banks to spin off divisions which do proprietary trading, but that is not definitive yet. 

Consumer Financial Protection Bureau
The bill also sets up an independent Consumer Financial Protection Bureau, which will be housed in the Federal Reserve and will be headed by a single director appointed by the President and confirmed by the Senate.  The new bureau would write and enforce rules for most banks, mortgage lenders, credit card, and private student loan companies.  Smaller banks and credit unions, or those with less than $10 billion in assets, will have to obey the consumer bureau's rules.  That will include the largest 106 banks in the nation.  Current data points to Capmark Bank based in Midvale, UT as the largest bank that would be exempt from the regulation.  For comparison purposes, the top 10 banks in terms of assets average more than $665 million.  The effect on Main Street is that people could think they are actually "protected" and still go about being very nonchalant with their money.  Some of our current troubles revolve around consumers spending beyond their means.  If this "protected" word begins to float around, people could misinterpret the meaning. 

Mortgages
The bill makes some changes that are supposed to prevent something like the housing crisis from occurring again.  It requires that lenders now have to check borrowers' income and assets.  Seems that most companies have already learned this lesson, and if they haven't, they probably aren't in business anymore.  A New York Times article equates this portion of the bill to "like closing the barn door after all of the animals escaped."  So this means banks will be forced to check someone's ability to pay these loans, but it will be interesting to see how the government will force the banks to lend next.  Part of the HAMP, and other housing programs, has been reliant on banks to loan money more freely. 

Other rules include a ban on prepayment penalties for people with adjustable rate and other more complex mortgages.  Additionally, there will be no incentive to push higher interest loans on borrowers.  Julia Gordon, senior policy counsel for the Center for Responsible Lending, said there will now be a cap limiting mortgage origination fees to 3 percent of the loan.  There are exceptions for required upfront mortgage insurance premiums, say for a Federal Housing Administration loan, and for points that borrowers elect to pay to lower the mortgage interest rate.

Credit and Debit Cards
The bill will give credit card companies the ability to charge a minimum usage charge, but it can't be more than $10; that is unless the Federal Reserve says it can be.  This could become one of those unforeseen consequences as the changes could be done across the board or an individual basis.  Merchants are also free to offer discounts to people who pay cash instead of using cards, or use debit instead of credit cards. They will not, however, be able to charge one price for people using American Express cards and a lower price for people using Visa and MasterCard credit cards.  The effect on Main Street could be both positive and negative.  Retailers are cheering the news as it will lower their costs associated with debit card transactions, and maybe consumers won't buy that extra shirt if its costs $2 more to use your credit card (instead of cash or debit).

Bank Tax
Over the objections of Republicans, House and Senate Democratic lawmakers also agreed to charge big banks fees to cover the costs of the bill, including $3 billion in funds to be used to help unemployed homeowners avoid foreclosure. A new financial stability oversight council will impose the fee structure and the Federal Deposit Insurance Corp. will collect the assessment from the largest financial companies to offset the net deficit effect of the bill.  Over the next five years, the government expects to collect almost $20 billion, which will be used to lessen the federal deficit.  Right, just like Obamacare will lessen the deficit too.  I wonder if the effect of lost tax revenue or slower business operations were used in that calculation. 

Insurance
Ever since American International Group (AIG) nearly ended the world as we know it (alright that was a bit of an exaggeration, but remember the twelfth hour deal making behind closed doors that supposedly saved the financial system), insurance companies have been at the forefront of financial regulation reform.  Then there were announcements that insurance companies around the country were increasing principal payments in some cases more than 30%.  On Friday, June 25, Aetna Inc (AET) announced it withdrew its filing for a 19% rate increase for California's 65,000 policy holders.  The withdrawal came after "substantial mathematical errors" were found.  Aetna follows WellPoint's (WLP) Anthem Blue Cross unit which in April withdrew its filing to increase rates by 25% in California.  The new bill will create a new Federal Insurance Office within the Treasury Department to monitor the insurance industry, recommending to the systemic risk council insurers that should be treated as systemically important.  The bill would also require the new office to report to Congress on ways to modernize insurance regulation.

So all these "reforms" are supposed to prevent another financial crisis, but does anyone think that the banks haven't already found a way around these rules?  Profits may be hurt in the short term, but these are some of the smartest people and are sure to find a way to continue to make money.  That being said, all these stipulations add more costs to the banking industry, but I do not think it will be the companies paying these charges; it will be passed on to the consumer.  There are already rumors of a charge for a checking account.  Commerce Bank (which was purchased by TD BankNorth) used to advertise totally free checking meaning they would give the consumer checks, a free debit card, and all the other amenities.  Now the perception is that banks will charge for a simple, basic, normal checking account.

The banks are going to pay for these changes to take place (the added levels of bureaucracy) and be forced to have a higher level of capital on hand.  Also, these banks are expected to increase the amount they lend while making restrictions harder.  All these things equate to one thing in mind, consumers are going to be paying more for less.  Not just that, but by forcing banks to hoard more cash, it will likely put a leash on whatever economic growth we have been seeing.

David Silver
Wall Street Strategies