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Inside the Financial Reform Bill

Posted by Jamie Downey  June 30, 2010 01:39 PM

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Passage of the Wall Street Reform and Consumer Protection Act appears imminent in the next week or so. Certain improvements to the financial services industry are no doubt in order. However, increasing regulations in one of the highest regulated industries in the country is not likely to reduce the risk to the industry. Here are a few thoughts on the bill:

Investment bank reform – Prior to the recent banking crisis, the United States housed the five largest investment banks in the world, Goldman Sachs, Merrill Lynch, Morgan Stanley, Lehman Brothers and Bear Stearns. Only two of these institutions, Goldman Sachs and Morgan Stanley, remain independent and they are substantially restructured from their former self. The others have either gone through bankruptcy or were acquired in a distressed sale. The market has already applied significant pressure on these entities to correct their misguided past. Does the industry really need the government piling on?

Fannie Mae and Freddie Mac – The Wall Street Journal projected losses at these two entities at over $370 billion through 2020. Losses at these entities will dwarf the losses incurred from the TARP funds (Wall Street Journal estimates this at $89 billion). However, the Wall Street Reform and Consumer Protection Act does not address any type of corrective action for either Fannie Mae or Freddie Mac. Are these not the entities that should be under the most scrutiny?

Community banks – Local and community banks are under much more pressure these days than larger banks. All banks have had significant loan charge-offs in recent years. However, larger banks have accessed the public markets and TARP funds to obtain additional capital. Smaller community banks have been pretty much shut out from these forms of capital. As such, community banks are likely to be less capitalized than their larger bank counterparts. Additionally, the personnel costs incurred to comply with federal and state regulations are one of the largest non-interest related expenses for community banks. This will only get worse as this 2300 page bill becomes law and volumes of new regulations are added. Prepare to see a significant wave of consolidation in coming years in the community bank sector. This will actually increase the size of the larger banks (too big to fail?) and reduce competition.

Higher capital requirements – The new regulations will require banks to have more capital than they did in the past. This will certainly reduce the risk exposure for banks. It will also reduce a banks ability to be profitable and reduce available credit for borrowers. Furthermore, community banks have much less access to capital and many will struggle to meet these new requirements.

TARP – The Troubled Asset Relief Program was no doubt a success. During the banking crises, banks need capital infusions to sure up their balance sheets and public confidence. This mission was accomplished and most of the large institutions have paid back their TARP funds in full with interest. In many cases the US Government will profit from the transaction in the form of warrants received. The four largest losses in the TARP portfolio will come from AIG, General Motors, GMAC and Chrysler. Not one of these entities held a bank charter prior to the crisis. Providing bank funds to GM and Chrysler was a political quid pro quo. Maybe regulating auto manufacturers would be more appropriate than regulating banks.

Derivatives – Warren Buffett has referred to derivatives as “financial weapons of mass destruction”. While this can be true when used for speculative purposes, the purpose of entering into a derivative position is to reduce risk. Even Mr. Buffett will admit that his company, Berkshire Hathaway, has billions of dollars in derivative products. Like all rational bankers, he uses these to limit risk exposures. The government wants to limit the use of a product that can actually reduce a bank’s financial risk.

Propping up residential home prices – For years the Federal Reserve and the government have been propping up the value of homes with various incentives to encourage home ownership. These incentives played an important role in the dramatic increase in home prices through 2006. However, the subsequent fall in residential values was the foundation for the entire financial meltdown. How has the government and Fed responded? They have implemented new incentives to prop up the market such as 30 year fixed loans at 4.875% and $8,000 tax credits. Those that don’t learn from history are bound to repeat it.

This blog is not written or edited by or the Boston Globe.
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Local finance professionals share insights and advice on issues such as budgeting, managing debt, and retirement planning.

About the contributors

D. Abraham Ringer is a CERTIFIED FINANCIAL PLANNER practitioner and a Financial Adviser with Morgan Stanley Global Wealth Management in Boston. He is registered in MA, NH, NY and several other states to which his articles are directed. For more information please visit
Financial Planning Association™ of Massachusetts has 900 members who specialize in the financial planning process. Many of its members engage in philanthropic pro bono work in their communities, recommend legislation, elevate public awareness, promote financial literacy, and advocate for sound economic and tax policies.
Odysseas Papadimitriou is the founder of, a credit card and gift card marketplace, and, a personal finance site. He has more than 13 years of experience in the personal finance industry, and previously served as senior director at Capital One.

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