The Good, the Bad, and the Uncertainty on the Financial Reform Legislation

This morning, June 25, at 5:39am, House and Senate negotiators reached agreement on financial reform legislation. The full details of the final proposed legislation will be revealed over the few days, prior to the Senate and House votes next week, here. It would be premature to comment on precisely how the bill will affect the financial services industry until the details are known. The angels, as well as the devils, are sometimes found in last minute words changed and clauses added or subtracted. But here are some high level comments.

Let’s begin with the good.

The legislation is done. Assuming it gets final passage by the House and Senate and is signed by the President, as is widely expected, it removes significant uncertainty about what financial firms can and can’t do. Managers and investors can now make decisions with a better idea (see below, though) on what the rules of the game are.

The opportunities for ill-considered attempts to load in regulations over pet peeves by Congresspeople, or to exempt various special interest groups, have come to an end for now. Over the last year lots of ornaments have been added to or taken away from the Congressional Christmas Tree.

The final legislation looks much better, in various respects, than it did along the way. Much of the over-the-top behavioral economics regulation of consumer credit was excised early on from the CFPA part of the bill—plain vanilla remains an ice cream choice and not a government designed and mandated financial product. A last minute amendment requires the new agency to consider the impact of its rules on small businesses. That will reduce something that worried me and others greatly—that the new businesses that account for a significant part of job growth would be collateral damage.

Then there’s the bad.

As I’ve mentioned in Spin and Duck: Washington’s Failure to Pursue Real Financial Reform, the Obama Administration and Congress did a double disservice to the American public. On the one hand the legislation simply doesn’t deal with many of the profound problems with financial services regulation including the multiplicity of bank regulators and the opportunity for them to be captured by the banks. On the other hand the legislation ended up becoming a place for special interest groups to load things into. The Durbin amendment will in my view result in a massive transfer of wealth from consumers to retailers at least in the near term. It will also put the Federal Reserve Board, the government entity that has propped up paper checks for all these years, in charge of the highly innovative payments industry. This is like putting the Post Office in charge of email.

And finally there’s the uncertainty.

Although some uncertainty has been resolved, much remains. The legislation provides a canvas on which regulators have been empowered to paint whatever they want. For the payments industry the regulator to watch is the Federal Reserve Board. It has two new roles.

First, it has been charged with imposing price regulation on much of the debit and prepaid card industry (minus whatever parts got special exemptions). But the legislation gives it broad parameters on how to do that. There’s going to be a lot of work done here. A few basis points one way or another in their calculations adds up to a lot of money for the banks.

Second, it has been charged with housing the Consumer Financial Protection Board. At this point it is unclear whether the Fed is simply renting out office space to what will be a whole independent entity or whether the usually sensible Fed will actually have some control over what this new entity does. Speaking of uncertainty, in terms of what kind of regulations the credit industry (broadly defined minus whatever parts got special exemptions) will face a lot depends on who is approved to be the new credit czar. There many people who are logical (from the Administration’s perspective) candidates for this position who really believe that giving people credit is much like giving alcoholics a drink. Hopefully, the Senate will only approve someone who has a balanced opinion on the benefits of credit and the need to consumer protection.

So this morning wasn’t the end of the debate on financial reform in the US. In many ways it is just the beginning of a process that will go on for a very long time. Stay tuned for more analysis as we learn more about the angels and devils in the several thousand pages that will soon be posted online.