Banking reform takes shape in Congress
St. Louis bankers are aghast, consumer advocates are delighted and retailers have their fingers crossed.
That’s the situation as the U.S. Senate and House get ready to iron out the differences in their banking reform packages this month.
Meanwhile, debate goes on over whether the bills will accomplish their biggest goal — preventing a repeat of the bacchanal of brainless lending that nearly collapsed the financial system in 2008 and plunged America into recession.
In St. Louis, the howls are particularly loud from area bankers who fear they will be forced to cut the fees they charge merchants for debit card transactions, while being stuck with higher costs for complying with new consumer protection rules.
The bills contain "several very alarming things," says David Kemper, CEO at Commerce Bank, the largest bank based in St. Louis. He says the bills could cut 5 to 8 percent from pre-tax earnings. "We’re all for consumer protection, but at what cost?"
Consumer groups are hailing a rare victory over the bankers. "It’s amazing. The bill could be stronger, but given how much political muscle the industry has, this is really good," said Kathleen Day of the Center for Responsible Lending.
The House and Senate bills have their differences, but they are similar enough so that a probable outline of the final bill is emerging. Here’s a review:
A new consumer protection agency and new rules for banks — Both bills would establish a new agency with broad authority to set rules for consumer lending. The rules would cover banks, payday lenders, finance companies and the like. However, the agency couldn’t set a limit on interest rates, and it probably wouldn’t have authority over auto loans made through car dealers.
The House excluded auto dealers. The Senate didn’t, but the Senate later told its negotiators to exempt the dealers. Auto dealers arrange 79 percent of all car loans, according to the Senate Finance Committee, and dealers often add their own profit to the price. Banks and credit unions complain that they will be subject to consumer protection rules on car loans whereas the dealers won’t.
The bills also contain new rules on mortgages, requiring lenders to assure that borrowers prove they have enough income to make their payments.
Bankers complain that they will be stuck with the cost of paying for the consumer agency, and the government examiners who will troop through banks making sure the rules are obeyed. Such costs get passed on to customers, bankers say.
The consumer rules might limit innovation in credit cards, home improvement loans, mortgages and the like, banks say. That, in turn, might prompt them to stick to plain-vanilla lending rather than risk running afoul of the consumer agency, leaving less choice for borrowers.
Max Cook, president of the Missouri Bankers Association, thinks the consumer agency will become a tool of consumer advocacy groups. "Our greatest fear is that this is their platform," he said.
Giant financial institutions will have to raise more capital — Financial institutions deemed "systemically important" would be put under the thumb of the Federal Reserve under the Senate version. The Fed’s reach would go beyond commercial banks into big investment banks and other financial companies whose failure might threaten the system.
One of the most expensive failures of 2008 was the insurance conglomerate AIG, which was hardly regulated at all. Taxpayers have paid more than $170 billion so far to prevent its collapse.
Financial giants are linked to each other through a web of obligations. The failure of a single giant player can weaken others, potentially leading to more failures. Fear of that domino effect helped set off the panic of 2008, which nearly froze the credit system, and brought on a $700 billion taxpayer bailout.
To head off a repeat, the Fed could force big players to reduce risk and raise capital — a cushion of shareholders’ money that can absorb losses and prevent failure.
Controlling how big banks would fail — Institutions thought to be "too big to fail" might be allowed to fail under the new bills, but they would do so in an orderly fashion. Both bills would let the FDIC seize big financial institutions — banks and other players — and wind down their operations in a way least likely to cause systemic shock.
That might mean paying off some creditors, while stiffing others.
The bills require that failing companies be liquidated, not rescued. Shareholders’ investment would be wiped out, while unsecured creditors would take a haircut.
Right now, institutions that lend money to a too-big-to-fail bank think they’re taking little risk. That’s already changing as credit rating agencies threaten to trim their ratings on the nation’s too-big-too-fail banks. Big banks will have to pay more for financing, and that could trim their profits and perhaps restrict their lending.
No bank based in St. Louis would be considered too big to fail, but several such banks operate here, including Bank of America, U.S. Bank and PNC Bank. Citigroup has no branches here, but it owns a large mortgage operation in St. Charles, and Wells Fargo’s retail brokerage is based in downtown St. Louis.
Disallowing proprietary trading for banks — Big players, and some small ones, are howling over a Senate plan to ban banks from risking their own capital by playing the stock, bond, commodities and derivatives markets. They would be able to handle such trades for others, but not bet the bank’s own money.
Wall Street banks have made a lot of money playing the markets. Ron Kruszewski, CEO of investment firm Stifel Financial in St. Louis, warns that such a ban could reduce "liquidity." Banning the banks will mean fewer players buying and selling, raising the price of transactions for all sides, including small investors.
The ban, called the "Volker Rule," isn’t in the House bill, but House Financial Services Committee Chairman Barney Frank has said he would go along with it.
Debate brewing on debit card fees — A proposed change in debit card rules may spark a fight when Senate and House negotiators meet. Sen. Dick Durbin, D-Ill., sponsored an amendment that would let the Fed set "interchange" fees paid by merchants when customers use debit cards. The fees, about 1 to 2 percent of the purchase price, are big sources of income for banks and a major complaint of retailers. There’s no such thing in the House bill.
The Senate amendment also would let merchants offer discounts for customers who pay with cash or checks rather than credit or debit cards. Banks warn that the loss of fees could cause them to stop offering rewards, such as airline miles or cash back, to customers who use debit cards.
Some small banks may boost fees for checking accounts, Cook said. "All those banners that say ‘free checking’ are being taken down," he said.
Merchants say they will be able to lower prices, although it would also raise store profits.
New way to sell derivatives — Derivatives helped push some institutions over the brink during the credit crisis. The bills would force derivatives to be sold through clearing houses, which would make sure the companies issuing derivatives have the money to back them up. Most derivatives would also have to be traded on exchanges, which makes prices clearer.
Derivatives can be used to hedge risk, or to take risk on. AIG failed largely because it issued credit default swaps — the equivalent of insurance — on mortgage bonds. When the bonds began to weaken, AIG couldn’t pay up.
So, would these changes prevent the next big financial mess?
Dave Rolfe, chief investment officer at Wedgewood Partners in Ladue, has his doubts. Regulation doesn’t prevent catastrophe if the regulators aren’t sharp, and can’t fend off political pressure from the industry.
"Look at Fannie Mae and Freddie Mac. They failed miserably," said Rolfe, noting that the mortgage giants had a special federal regulator.
Stifel’s Kruszewski, who runs a brokerage and investment firm, says the bill fails to completely control "weapons of mass financial destruction," such as credit default swaps and synthetic collateralized debt obligations. Such derivatives allow speculators to make massive bets in the credit markets, raising the risk level in the system.
Kemper, of Commerce Bank, says the bills would put too much cost on small and mid-sized commercial banks, which had nothing to do the subprime mortgages and speculation that caused the crash.
"You don’t want to turn the banking system into the domestic airline business."