Wall Street Reform is Finally Here, But Why Should We Care?

On Wednesday, July 21, President Barack Obama signed the Wall Street reform bill into law. After several months of negotiating among lawmakers in Congress, the road to come to a final resolution was not an easy one. But now we have been given a sweeping overhaul that will make more changes to the financial sector than we’ve seen since the 1930s. With the financial reform bill being signed into law, it’s time to take a look at what changes have taken place.

What’s In the Wall Street Reform Bill?

Let’s dive right in and look at the legislation, which is officially known as the Dodd-Frank Wall Street Reform and Consumer Protection Act. In it, there are a number of changes that could affect you in the near future. They include:

1. New Credit Lending Guidelines

Residential mortgage lenders will now be required to compare costs in a transparent way that will tell borrowers how they can receive the lowest price for their mortgage. Also, lenders will have to follow the guidelines of the Truth in Lending Act, which requires lenders to verify whether a borrower really qualifies by looking at their income and credit history to determine whether they will be able to repay the total cost of the loan, including taxes, insurance and other fees.

Additionally, homeowners who are unable to make their mortgage payments as a result of the loss of a job or due to a medical condition may qualify for up to $50,000 in assistance through HUD’s Emergency Mortgage Assistance Fund.

2. FDIC Increase Becomes Permanent

As a result of the financial crisis, the Federal Deposit Insurance Corp. (FDIC) decided to temporarily increase the amount of money it would insure in bank accounts from $100,000 to $250,000. Now the new banking regulation will allow customers who hold money in banks insured by the FDIC to permanently take advantage of the $250,000 limit.

3. No More Risky Banking Practices

According to the new banks regulation, financial institutions will be required to hold additional capital to cover potential losses. Also, banks will be required to retain at least 5 percent of a loan on their books if that loan is sold or repackaged with other loans and securitized. And they will be limited in their ability to engage in proprietary trading in their own accounts as this represents a conflict of interests.

In addition, the Federal Reserve will oversee a newly-created Consumer Financial Protection Bureau that will regulate consumer financial products and services.

4. Large Bank Liquidation Overseen

As a part of the reform bill, a new Financial Stability Oversight Council will be in charge of assessing and managing risks that could threaten the U.S. financial system. In addition, the FDIC would be in charge of managing the liquidation of a bank that fails and is deemed by the Treasury Secretary as one that would disrupt the stability of the nation’s financial system.

Some additional responsibilities of the FDIC would include:

• Firing corporate management responsible for the failure.
• Stopping any payments to shareholders until other claims are paid.
• Borrowing from an Orderly Liquidation Fund to pay for liquidation as long as taxpayers are not responsible for financing the fund.

The FDIC and Federal Reserve will not be allowed to lend to insolvent companies or banks. However, they may both lend funds to provide liquidity.

5. Improved Transparency from Investment Firms

There have been reports that 401k details will become more transparent soon as a result of Wall Street reform. Now all investment firms, including hedge funds and private-equity advisors will not only be required to determine the amount of their global financial exposure to derivatives, they will also be required to register with the Securities and Exchange Commission (SEC) and disclose their commission information in a public forum.

Will Wall Street Reform Stop the Next Crisis?

Much of the motivation behind overhauling the financial system was the financial crisis that began with the downfall of the subprime mortgage loan. In addition, the overhaul was created to ensure that no company would ever be considered “too big to fail” again. So is it possible that all of the overhauls will prevent another crisis?

In April 2010, before financial reform became a law, former Federal Reserve Chairman Alan Greenspan admitted that another crisis was possible unless a couple of important changes were made. One was that higher capital requirements were put in place so that there would be adequate risk-based capital and liquidity available for companies.

The other idea Greenspan proposed was that banks would be required to hold a special type of “contingent capital bond” that would automatically convert into equity if the institution’s equity fell below a certain level.

So has the overhaul addressed these issues? Obama believes that the new rules will address these and other issues. But only time will really tell whether we will see another crisis like the one we’ve experienced over the past two years.