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Senate financial reform bill: Needed reform gone bad

Senate Passes Regulatory Restructuring Bill – Introductory Summary

Last night (Thursday, May 20, 2010) the Senate attached S. 3217 as an amendment to H.R. 4173, and passed it on a vote of 59 – 39. Both Senator Inhofe and Senator Coburn voted “NAY”.  Both Senators have been  consistent in their support for fending off threats and challenges to Oklahoma consumers and their financial institutions, including the state's traditional community banking industry.  
Three Republicans voted for the bill: Grassley (R-IA), Collins (R-ME) and Snowe (R-ME). Two Democrats voted against the bill: Cantwell (D-WA) and Feingold (D-WI. 
The Senate version of financial reform is different from the House version in a number of significant respects, including lending limits for state-chartered banks, interchange price limitations, preemption, treatment of trust-preferred securities and the establishment of a new consumer agency. Those differences mean that there will have to be further negotiations between the House and Senate leadership to resolve them either formally or informally. Once an agreement is reached, then the result can be submitted to both the House and Senate for approval. 
The bill's passage is no “victory” for traditional community banks, regardless of what some might think. Main Street got hammered, without accomplishing the most important goal – ending “too-big-to-fail” as a matter of national policy. In fact, that's the precise reason that Senators Feingold and Cantwell voted “NAY”, and it's why Senator Coburn helped lead the charge on this critical point. 
There's plenty of “bad news” in the underlying text. Here are just a few of those items: 
1. Consumer Financial Protection Bureau
The bill creates a new, expensive and totally independent Consumer Financial Protection Bureau. It's housed in the Federal Reserve, but has no adult supervision.   No input or involvement by prudential regulators in making the rules is required for the new bureau which has exceptionally broad powers. It can make up new rules that govern every aspect of every customer relationship in your bank. 
While community banks are not examined directly by the Bureau, they are subject to its rules. Wall Street firms regulated by the SEC and the CFTC are exempt from its reach, as is the Farm Credit System (FCS).   As a result, banks that did nothing to cause the financial crisis will be subject to heavy new and conflicting regulation, while certain non-bank competitors may have little or no new regulation.
The new consumer bureau would have broad authority to prohibit “unfair, deceptive or abusive” acts and practices. No one knows what the term “abusive” really means, and most likely it will be determined “after the fact” by consumer advocates. Not good.   
Unlike current banking agency enforcement actions, which generally limit “cease and desist” monetary relief orders to restitution and rescission, the new consumer Bureau's enforcement authority includes the payment of damages. There is also a provision for recovery of costs from covered persons by the CFPB, state Attorneys General, or state regulators.
The new “Financial Stability Oversight Council” has the ability to block a proposed rule, but the reality is this “power” is only on paper. To block a proposed rule, two-thirds of the nine voting members of the Council must reject it, but only if it had made an official determination that the rule in question would put at risk the “safety and soundness” of the U.S. banking system or the “stability” of the financial system. Marvelous.
2. Interstate Branching
The Senate-passed bill removes Oklahoma's restrictions on de novo interstate branching.
3. Too-Big-to-Fail
Many people believe that the bill does not end “too-big-to-fail”. Here's how we read it: The bill creates a liquidation mechanism for the FDIC to act as receiver to unwind failing institutions where the failure would cause systemic risk. Shareholders and unsecured creditors would bear any losses and management would be removed. So far so good.  
BUT: There will have to be agreement between the FDIC, the Federal Reserve and the Treasury before any firm can be placed into a liquidation process. The FDIC is permitted to guarantee debt but would be subject to Congressional oversight. The Fed's authority to provide assistance would be subject to new restrictions, but it can still be provided. Many who read this language providing for “exceptions”  that permit debt guarantees and financial assistance, and then compare it to what would happen if your bank failed, come away with the conclusion that TBTF is not “over”, and that more should be done to end this flawed policy.
The pre-funded “too-big-to-fail” fund of $50 Billion was eliminated.
4. New Regulatory Requirements and Costs
Where to begin? These new requirements will impose a myriad of unnecessary regulatory requirements and costs on traditional community banks that have absolutely nothing to do with the underlying causes of the financial crisis.  Some highlights: 
o   Banks and other financial institutions will be required to provide consumers with expanded access to account, transaction, fee, and other information, with exceptions for confidential commercial information and suspicious activity reporting.  
o   For small business credit applications, you'll have to collect data about whether the business was women or minority-owned, the amount of credit applied for, the type of action taken on the application, census tract location of the business, gross annual revenue of the business, race and ethnicity of the principle owner, and any additional information the CFPB wants. The information would have to be submitted to the CFPB annually and retained for three years and made available to the public on request.   
o   Expanded HMDA reporting to the CFPB will be required. New data fields include age of borrower, points and fees charged, prepayment penalties, value of property, terms of loan allowing for payments resulting in less than full amortization, credit score, and other information.
o   In addition, the CFPB would be expressly empowered to gather information from “covered persons” (i.e., you and your bank) and service providers on their organization, business conduct, and practices.
o   In addition, new requirements for disclosures in connection with remittances would also be imposed.
5. Preemption – Some good news here: 
Essentially present law under the Barnett Bank standard (Barnett Bank of Marion County N.A. v. Nelson) remains intact, which is a good thing. Unfortunately, state attorneys general will now have the ability to enforce applicable state and federal consumer laws. 
6. Systemic Risk Council
The bill creates a nine-member “Financial Stability Oversight Council” chaired by the Secretary of Treasury. It also includes an independent member with insurance experience appointed by the President, and representatives of the Fed, Federal Deposit Insurance Corporation (FDIC), OCC, SEC, CFTC, the Federal Housing Finance Agency (FHFA), and the new CFPB.
The Council's duties would be (among other things) to identify institutions and practices that might pose a systemic risk and make recommendations to the members of the Council for standards to address such risks. The House bill includes language requiring the Council to review and comment on accounting practices and standards but the Dodd bill does not contain this language.
The Council can make recommendations to the Fed regarding new and higher regulatory standards for financial companies as they grow larger and more complex, including more stringent capital, leverage, and liquidity requirements. Large, complex companies would be required to submit credible “funeral plans” for their rapid and orderly shutdown should they fail.
The Council also may direct that a covered institution sell assets if this is needed to mitigate a threat to the United States.
7. Deposit Insurance Assessments
The base for the FDIC assessment was changed to total assets minus tangible equity capital, thanks to an amendment by Senator Kay Bailey Hutchinson (R-TX).
8. Skin-in-the-Game Requirement
The “skin-in-the-game” requirement for mortgage originators – which would have seriously undermined mortgage lending activities by community banks everywhere – was modified to exempt mortgages underwritten to “conservative” standards to be developed by banking regulators. That amendment was offered by Senator Mary Landrieu (D-LA). In addition, Senator Crapo (R-ID) offered an amendment  and by requiring that risk retention standards imposed on commercial real estate take into consideration the unique nature of commercial mortgage backed securities.
9. Federal Reserve to Retain State Member Bank Supervision
Senator Hutchinson also offered an amendment to make sure that the Federal Reserve retains its authority for oversight of state member banks, a significant improvement to the Senate's underlying text. The amendment was approved overwhelmingly.
10. “Volcker” rule
The bill includes a modified version of the so-called Volcker Rule that restricts bank proprietary trading. The regulatory agencies would be required to issue rules, in accordance with the recommendations of the Council, for banks, bank holding companies, and their affiliates, to prohibit proprietary trading, investment in, and sponsorship of hedge funds and private equity funds and to limit relationships with those funds. The Fed would be required to impose additional capital requirements and quantitative limitations on those non-bank financial companies it supervises that engage in these activities.
11. Executive Compensation
In general, shareholders of public companies would be given a non-binding vote on executive compensation. These same shareholders also would be allowed to nominate their own candidates using the company's proxy ballots. The Fed is directed to promulgate rules prohibiting as unsafe and unsound excessive compensation paid to bank holding company executives, regardless of whether the company is publicly traded.
12. More Bad News: 
·         The Durbin amendment mandates that the Federal Reserve set interchange fees for debit cards based on the “reasonable” cost of conducting the specific transaction.   No provision is made for costs of development, maintenance or profitability.  It also allows merchants to discriminate by “steering” customers to specific types of credit and debit cards through discounts or in-kind incentives. Merchants are also permitted to set minimums and maximums for credit card transactions.
·         The Collins amendment requires bank regulators to set minimum capital levels for holding companies that are as strong as those required for their insured depository subsidiaries.
o   However, the components of capital for holding companies are restricted to the components of capital allowed for insured depository institutions, which excludes trust-preferred securities.   
o   It also does not include Treasury's investments in holding companies under the TARP Capital Purchase Program.
o   The amendment also eliminates the “small bank holding company” exemption and contains a number of other negative provisions.
·         The Merkley-Klobuchar amendment bans yield spread premiums for mortgage brokers and loan originators. In addition, it imposes an “ability to repay” standard on all loans which will drive up compliance costs, and restrict the availability of some loan types, such as balloon loans.
·         The Dodd-Lincoln substitute amendment requires all banks to “push-out” their derivatives activities, which will prevent community banks from engaging in loan level hedging programs. It would impose fiduciary duties on swap dealers when engaging in swap transactions with state and local governments, pension plans, and even Fannie Mae or Freddie Mac. It gives banking regulators the ability to impose margin and/or capital requirements for an existing swap contract, and gives certain counterparties the ability to change the terms of existing contracts by calling for margin “on demand,” even if such calls would increase systemic risk.
·         State lending limits in Oklahoma are lowered to the national bank standard. 
·         Federal Home Loan Bank advances are subject to certain limitations that will adversely impact lending in Oklahoma.
Working closely with our colleagues in the other 50 states and the American Bankers Association we were able to kill some even worse amendments that were proposed, but that's still no cause for celebration. Some of these proposals included: 
o   Caps on interest rates offered by Senator Bernie Sanders (I-VT);
o   Reinstating State usury limits on a state-by-state basis, thus overturning the Supreme Court's Marquette decision. This was the Whitehouse amendment;
o   Imposition of “concentration” limits on non-deposit liabilities; 
o   Mortgage cram down; 
o   Elimination of private student loan debt in bankruptcy; 
o   Authorization of private civil litigation for aiding in securities law violations; 
o   Caps on ATM fees;
o   Reinstating Glass-Steagall prohibition on insurance and securities activities in banks
There are other provisions in this massive legislation, dealing with hedge funds, derivatives and other matters. More will be forthcoming but these are some of the highlights that are of importance to many traditional community banks. 

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