Consumers gain from financial reform

Perhaps, the biggest bombshell for banks may be limits placed on their investing activities. What began as the so-called "Volcker Rule," for former Federal Reserve Board Chairman Paul Volcker, now restricts banks insured by the FDIC in how much proprietary trading of stocks and other potentially risky financial instruments they can do. They are also restricted in their investments in hedge funds and private equity funds.

Regulating the regulators

Flaws in the U.S. regulatory system played a key role in the crisis. Regulators are funded largely by the firms they oversee to minimize the cost to taxpayers. Unfortunately, because there were several financial regulators whose jurisdictions overlapped, regulators ended up competing with one another to regulate large firms that could become a rich source of funding. This meant financial firms were able to go "regulator shopping" for the most lenient regulator.

"The regulators became captive of the institutions they were regulating," says Day. "They tended to pander to (large financial firms) because they didn't want them to leave and take their money."

The new legislation clarifies which regulators will oversee which types of firms. The Office of Thrift Supervision, or OTS, is the biggest loser. It was originally created to oversee savings and loan institutions, but it had expanded to cover several complex financial firms that eventually fell victim to the financial crisis. A recent Congressional Oversight Panel report found the OTS was largely responsible for the government's failure to foresee and prevent the collapse of AIG, which received billions of dollars in the government bailout. Under the act, the Office of Thrift Supervision will be merged with the Office of the Comptroller of the Currency.

Regulators also fell short in their ability to assess risk in the economy as a whole. To help make sure they see the next crisis coming, the act mandates that regulators share information on financial firms that present a danger to the overall financial system and keep an eye on risk in the wider economy.

To help them do this, the legislation establishes a new entity called the Financial Stability Oversight Council. Under the act, the Council, made up of the Treasury secretary, the Fed chairman and the heads of the various financial regulatory agencies, will meet regularly to discuss the health of the economy.

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