With a Democrat majority in both the House and the Senate, President Obama has been able to pass a trio of massive legislation - the stimulus, healthcare reform and financial reform. These are massive laws not only in terms of their impact on the country and its economy but also in sheer number of pages. In this and future articles we will look at the 2,300 page Dodd-Frank Wall Street Reform and Consumer Protection Act, which we will simply call "the Financial Reform Act." Today we will get an overview and in future articles will get a closer look at certain parts of this law, particularly those directly affecting consumers.
While most provisions became effective on July 22, 2010, the day after Obama signed it, this does not mean all of the impact will be felt immediately:
- The Financial Reform Act creates new federal agencies; one to broadly oversee the stability of the financial services industry and one to take primary responsibility for consumer protection. In addition, new bureaucratic levels are added within agencies. For example, all regulatory agencies covered by the Financial Reform Act must set up an Office of Minority and Women Inclusion.
- Although the law is detailed and specific in many ways, much of it will not be effective until regulations are adopted by the agencies. According to the law firm of Davis Polk there are 243 explicit mandates for rulemaking.
- A correction/clarification bill is anticipated. For example, in one place it refers to regulations being written by the Federal Reserve despite its authority for that regulation being transferred to a new agency.
- Multiple studies will be undertaken that could result in additional legislation or regulation. Davis Polk estimates that there will be 67 one-time reports or studies and 22 new periodic reports.
- Comprehensive as it is, it does not address everything. For example, it does not deal with the secondary mortgage market, including Fannie Mae and Freddie Mac.
Broadly speaking, the Financial Reform Act imposes increased scrutiny of Wall Street, banks, and consumer lending. To do this the framework of regulatory agencies has been redesigned. Many complained that the financial meltdown was due to insufficient regulations being in place and insufficient enforcement of the regulations that were in place. Many different agencies had the authority to write regulations for, and to enforce, various parts of the world of consumer credit. In some cases financial services companies were allowed to choose their regulator. To deal with all of this the Financial Reform Act creates not only new agencies but a new structure for the agencies.
Sitting atop the hierarchy will be the new Financial Stability Oversight Council. It is responsible for overseeing all of the other agencies and preventing another financial meltdown. It is intended to limit the risk of failure of large financial institutions, referred to as being "systemically significant," and, if they do fail, to liquidate them in an orderly manner so as not to bring down the entire system or require another bailout.
Here are just a few of the provisions affecting banks, Wall Street, and consumer protection.
While there will continue to be depository institutions known as "thrifts," which have some of the attributes of national banks, the Office of Thrift Supervision has been eliminated and thrifts will be regulated by the FDIC and the other federal bank regulators. The Financial Reform Act will result in new agencies, departments and offices, but this is the only instance in which an existing agency has been eliminated
During the financial meltdown the amount of an account in a national bank insured by the FDIC was increased from $100,000 to $250,000. One of the provisions of the Financial Reform Act that became effective on July 22 was to make this higher amount permanent.
Some of the other significant changes for banks include:
- tighter lending limits and potentially more stringent capital requirements;
- more supervision, examination and enforcement power of the regulators;
- restrictions on mergers and acquisitions of large banks;
- limitations on investment activities of banks (known as the Volcker Rule); and
- a moratorium on the creation of new "nonbank-banks" such as credit card banks and industrial loan companies.
Much of the blame for the financial meltdown was placed on the SEC for being lax in its oversight responsibilities. As with the bank regulators the SEC will have more power to supervise its covered firms, but it will also be subject to more supervision itself, including having to provide Congress with reports on its management and internal controls. It will be reviewed periodically by the Comptroller General.
To help promote transparency for investors more disclosures will be required in securities transactions, and to broaden the scope of oversight more entities and investment vehicles will be subject to regulation. For example, many private advisors will now have to register with the SEC and most swaps will have to go through a clearinghouse and be traded on a formal exchange.
Broadly speaking the goal of the Financial Reform Act could be said to be consumer protection in the sense that maintaining a healthy financial system is good for consumers and some of the provisions relating to banks and Wall Street are specifically for the benefit of consumers, but two major parts of the law are directed exclusively to consumer transactions: the creation of a new agency responsible for all consumer financial protection and a series of new regulations for the home mortgage industry.
New Comprehensive Consumer Financial Protection Agency
One of the most significant changes to consumer credit regulation in decades is the creation of the Bureau of Consumer Financial Protection due to the breadth of its coverage. Currently, a number of agencies are responsible for different aspects of consumer lending depending on the regulation and the type of lender. The Bureau, once it is up and running, will be responsible for updating and enforcing regulations for almost all consumer protection laws, including the
- Consumer Leasing Act;
- Equal Credit Opportunity Act (ECOA);
- Electronic Fund Transfer Act (EFTA);
- Fair Credit Billing Act;
- Fair Debt Collection Practices Act; Home Mortgage Disclosure Act (HMDA) ;
- Real Estate Settlement Procedures Act (RESPA);
- Truth in Lending Act;
- Truth in Savings Act; and
- nine other laws.
Auto dealers, real estate brokers, insurance agents and persons regulated by the SEC are exempt, but banks, mortgage companies, payday lenders, private student loan lenders, appraisers, loan servicers, debt collectors, and most other companies that provide financial products or services to consumers are covered.
How the Bureau fits into the regulatory framework may be described as a "dotted-line" relationship to the Federal Reserve Board. It will be a new office within the FRB, but will be independent, and the FRB is specifically prohibited from interfering with the management and functions of the Bureau.
New Mortgage Regulations
Some of the new regulations will apply to all mortgage loans and some will apply only to certain types of loans. There will be new regulations applicable to:
- all mortgage loans;
- high-risk mortgage loans;
- qualified loans; and
- high-cost loans.
Perhaps the most important new mortgage rule, and the one that may lead to the most litigation, is that all lenders must reasonably ensure that the borrower has the ability to repay the loan based on the circumstances at the time the loan is made. Thus, there is not only a quantitative increase in the number of regulations that must be followed by mortgage lenders, there is a fundamental change in that lenders will have at least a quasi-fiduciary duty to borrowers. Since lenders will need to see tax-returns, W-2 forms etc. to make this determination it means there can be no more of the loans often referred to in the industry as "liar loans," "no-doc loans" or "stated income loans," which have been considered one of the causes of the mortgage crisis.
Although the law has contradictory provisions on this, it is assumed that the Bureau will have the authority to write these new regulations and that this will be clarified in a follow-up bill.
Timeline for Implementation
The Financial Reform Act requires the Secretary of the Treasury to choose a "designated transfer date" when the consumer protection power of the other agencies, as well as their personnel, will be transferred to the Bureau. This date can be up to 12 months after the date of enactment. Treasury Secretary Timothy F. Geithner used the full 12 months and set July 21, 2011 as the designated transfer date. He can, with an explanation to Congress, extend the date up to six months. The new mortgage regulations must be implemented within 18 months after the designated transfer date and, to give companies time to change their computers and procedures, will take effect 12 months after that. Depending on how long it takes the Bureau to finalize the rules, lenders must be in compliance probably sooner than, but no later than, January 21, 2014.
In the next article we will take a closer look at the Bureau of Consumer Protection and then at the mortgage rules.
Questions & Answers: Financial Services