President Barack Obama has proposed overhauling the U.S. regulatory structure to create a consumer-oriented regulator, consolidate existing agencies and set more strict rules for financial companies.
For individuals, the proposal offers greater consumer protection and relief from the hidden fees and confusing disclosure documents that have become commonplace in the market for mortgages, credit cards and other banking products.
Both houses of Congress must approve legislation for the plan to become law and the proposal will likely change along the way.
“There’s going to be a big push to get it done before the end of the year,” according to David Min, associate director for financial markets policy at the Center for American Progress, a Washington, D.C.-based progressive think tank. “A lot of it depends on how the banking sector does in the next six months.”
Officials hope that the financial market meltdown and massive federal bailout will provide the impetus to pass the proposal and help the millions of Americans struggling with credit card debt, burdensome mortgages and a faltering job market.
Simplified forms and disclosures
For consumers, the most relevant element of the plan is the creation of a Consumer Financial Protection Agency that would set and enforce rules for financial products, such as credit cards and mortgages, to ensure they are reasonable to be offered to the public.
“Consumers cannot compare financial products because the financial products have become too complicated,” said Elizabeth Warren in testimony to the House Financial Services Committee. Warren is a Harvard professor and head of the Congressional Oversight Panel reviewing the financial bailout.
“Picture it — a credit card contract that is two pages long, clear and easy to read, and that has a few well-lit blanks — the interest rate, the penalty rate, when a penalty will be imposed and how to get the free gift,” Warren said.
The Obama proposal calls for one-page summaries of financial products’ terms to supplement the multipage, legalistic disclosure documents that most people skim — if they read them at all.
“This agency will be able to write rules that promote transparency, simplicity and fairness, including standards for standardized, simple, plain-vanilla products that have straightforward pricing,” Treasury Secretary Timothy Geithner told the Senate Banking Committee.
Under the plan, consumers could easily compare plain-vanilla products being sold by different institutions. If banks wanted to offer more complex products, they’d have to jump through additional hoops to demonstrate that the customer was appropriate and understood the risks.
Crackdown on hidden fees and high rates
The new agency would be charged with fighting fraudulent and deceptive financial products in a bid to eliminate hidden fees and exorbitant interest rates on credit cards, mortgages and banking products with credit elements.
“It’s quicksand,” says Kathleen Keest, senior policy counsel for the Center for Responsible Lending. “You take one step knowingly but the 15 feet you sink down afterward is not your choice.”
For instance, some banks sign up customers for overdraft protection without giving them the required disclosures or a contract promising payment, Edmund Mierzwinski, consumer program director of U.S. Public Interest Research Group, told the House Financial Services Committee. Practices like this end up costing Americans $17.5 billion each year for cash advances.
“Consumers unwittingly borrow billions of dollars at astronomical interest rates,” said Mierzwinski. “The use of debit cards for small purchases often results in consumers paying more in overdraft fees than the amount of credit extended.”
For instance, a $35 fee on a $100 overdraft loan that the customer repays in two weeks equates to a 910 percent annual percentage rate, he said.
Impact on your financial institution
The plan also would eliminate the Office of Thrift Supervision and force existing thrifts or savings and loan institutions to become national banks under the jurisdiction of the Office of the Comptroller of the Currency. So if you are a customer of a thrift, your institution would either close or be required to become a bank.
Other financial firms would also be affected by more strict requirements for capital and liquidity, and beefed-up oversight generally. The goal is to prevent a repeat of the recent crisis, when institution after institution threatened to collapse.
“For consumers, there’s confidence that the government has acted, has plugged holes,” says Scott Talbott, senior vice president at the Financial Services Roundtable. “We’re never going to prevent another economic slump but we can minimize the impact.”
It’s possible that smaller banks will have trouble meeting the increased regulatory and disclosure requirements and close their doors or seek a merger.
“You’ll see some consolidation pressures,” Min says. “The cost of compliance may be higher.”
Fewer choices possible
Indeed, the banking industry has come out against the idea of creating a consumer-oriented agency simply to oversee products. It could actually harm the system to have one regulator looking at the soundness of the institution and another focusing on the products offered to consumers, Talbott says.
Moreover, if banks are forced to standardize products, the result will be fewer choices for customers. Instead of offering perks to good customers, such as free checking, they would revert to the lowest common denominator, says Mark Tenhundfeld, a senior vice president at the American Bankers Association.
“Banks may end up with fewer products and having to pay more for them,” Tenhundfeld says. “These costs are going to have to be passed on to the consumer. While there is this perception that the consumer is going to benefit from this additional layer of oversight, in practice we’re not at all sure that is going to be the case.”
The proposal could stifle innovation, preventing new products from ever reaching consumers. Many commonly accepted products, from variable-rate loans to laddered CDs, began as innovations.
“There’s probably going to be a tension between consumer choice here, and keeping things simple and understandable for the consumer,” Min says, noting that choice is not always a good thing for the public — such as during the mortgage meltdown. “You had a couple of good products being drowned out by the crappy products because mortgage broker incentives were misaligned.”
Keest notes that new agency would draw staff from the consumer divisions of the existing financial regulators. “This is not another layer of bureaucracy, it’s taking the same cars in the train and reassembling them under a different conductor,” she says.
Overview of the plan
The financial reform proposal stretches over 88 pages and is divided into five sections on robustly supervising firms, comprehensively regulating markets, protecting consumers, raising international standards and giving government the tools to manage financial crises. It calls for:
- Creating a Consumer Financial Protection Agency with a primary mission to protect consumers from abusive or fraudulent financial products. Companies would have to provide a one-page summary of disclosures to make it easy for customers to understand the terms.
- Creating a Financial Services Oversight Council that would guard against risks to the overall financial system and resolve turf wars between different regulators. Capital and liquidity requirements would rise for all firms, with the most strict rules for the biggest institutions.
- Giving the Securities and Exchange Commission, or SEC, and Commodity Futures Trading Commission more power to regulate over-the-counter derivatives, complex investments based on the price of another asset.
- Forcing large hedge funds to register with the SEC and open their books to regulators.
- Giving the Federal Reserve Board power over any large financial institution whose failure would threaten the financial system.
- Expanding the power of the Federal Deposit Insurance Corp. to take over and shut down faltering firms. All loan originators would have to keep 5 percent of the loans they package.
- Eliminating the Office of Thrift Supervision and forcing all savings and loans to become national banks under the oversight of the Office of the Comptroller of the Currency.