What Financial Reform Means to You

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The Dodd-Frank Wall Street Reform and Consumer Protection Act, otherwise known as Financial Regulatory Reform, will soon be signed into law by President Obama. The bill is 2,319 pages long – there’s no single article that can fully explain every way in which this sweeping legislation will ultimately impact your life, but it’s important to understand at least the basics, so let’s have a look.

First watch this 90-second video that reveals the broad strokes. Then we’ll go into more detail.

Now, a deeper look at exactly how this reform bill will impact your life in coming months and years.

Bank Bailouts

While the bill didn’t go as far as many wanted – for example, it doesn’t give the government carte blanche to preemptively break up banks it considers “too big to fail” – it did establish some new rules that could head problems off before they become systemic. It also should reduce the amount of money taxpayers would be required to shell out should good banks go bad.

  • In the case of a failing financial institution, the Federal Deposit Insurance Corp. (FDIC) will borrow from the Treasury to pay for the cost of liquidation, then get its money back by selling off the institution’s assets. If asset sales aren’t enough to repay the Treasury, the FDIC could charge a fee to other banks.
  • Payments to creditors of a failing institution designed to prevent a crisis from spreading will be limited to payments a creditor would receive in bankruptcy. In other words, money owed by failing financial firms to other companies might not be entirely repaid. This would prevent a repeat of the $160 billion taxpayer bailout of AIG.
  • If a bank fails, the FDIC will have the ability to take back compensation paid to its current or former senior executives for the two years preceding its failure. In addition, the government can ban senior executives found responsible for a bank’s failure from future work in the financial services industry.

Debit Card Interchange Fees

While final changes are still months away, the new bill will very likely save merchants money. Whether it will save any for you, on the other hand, is less certain.

  • Interchange fees, also known as “swipe fees,” are charges merchants have to pay Visa and Mastercard for processing debit and credit card transactions. The fee for debit cards currently averages 1.6% – credit cards’ swipe fees average more than 2%. Under the new law, the Federal Reserve can cap the fees on debit cards (but not credit cards) limiting them to what they decide is “reasonable and proportional to the actual cost incurred.”
  • It will take months for the Federal Reserve to decide what’s reasonable, but in Europe, Visa and MasterCard interchange fees are as low as .2% – in Australia they’re capped at .5%. Odds are that caps here will be higher than those charged on other continents, but lower than they are today. In lobbying for this change, retailers virtually assured Congress that they would pass along their savings to consumers. Many consumer advocates, however – including this one – are skeptical.
  • Merchants will be allowed to offer a discount to customers who pay with cards that carry lower transaction fees – that’s something that hasn’t been allowed in the past. They’ll also be allowed to set both minimums and maximums for card transactions.

Mortgage Lending

The changes made to mortgages will help assure that consumers are less likely to get nailed with high fees and bad loan terms.

  • The days of the “liar loan” are now officially over. Lenders will now be required to fully document a borrower’s income before agreeing to provide a mortgage loan. They will also be required to determine that the borrower can otherwise repay the loan.
  • The bill also prohibits lenders from offering incentives (called yield spread premiums) to mortgage brokers in exchange for originating loans with terms unfavorable to borrowers, such as higher interest rates.
  • Prepayment penalties for most mortgage loans will no longer be allowed.

The downside of these consumer protections? By making mortgages less profitable for lenders, they could become tougher to get for borrowers. For example, we’re already seeing stricter lending standards with higher required down payments.

Preventing another oil bubble

The ability of big Wall Street Banks to trade huge, unregulated derivatives contracts hasn’t been eliminated by the new law, but it has been curtailed. Many of the trades that in the past have been hidden from regulatory scrutiny will now be forced onto exchanges, where transactions will be more transparent. The reform bill also directs the Commodity Futures Trading Commission to create new rules designed to limit speculation.

While this provision of the bill may seem the least relevant and most obscure to many on Main Street, this change could theoretically provide the biggest change to the lives of many Americans in everything from the price of food to the price of oil.

To understand why, think back to July 2008, the days of $145/barrel oil and $4.00/gallon gasoline. While at the time the American public was assured that these prices were nothing more than the result of normal free-market supply and demand, some believe that the oil market was being artificially inflated by hedge funds and other big investors buying billions of dollars worth of oil futures contracts for no other reason than speculation. Prices on Wall Street – and at the pump – weren’t a reflection of the balance between suppliers and consumers. Instead, speculative demand created by unregulated trading pushed prices up.

According to CNN/Money, in a note to employees on April 23, 2010 Delta Air Lines CEO Richard Anderson summed up the issue for his company: “Prices are artificially inflated and volatility is created as a consequence of excessive speculation and trading by parties with no tangible need for the commodities.”

The new rules requiring greater transparency in the trading of derivatives contracts like commodities will make it less likely that undisclosed speculators will have the ability to manipulate markets.

There is a counter-argument from commodities speculators: that they increase market liquidity, which in turn allows end-users like Delta to use commodities markets to hedge their fuel prices in the first place. Some in the securities industry say that limiting speculation will create more price volatility, not less.

In coming months and years, we’ll find out if regulatory reform causes commodities and other derivatives markets to lose liquidity or gain stability along with accountability.

To get a greater understanding of derivatives, see our story What the Heck are Derivatives explaining what they are. Here’s an article from the Wall Street Journal (subscription required) that further explains how the new rules could affect the price of agricultural commodities.

Free credit scores

Consumers can already get a free look at thier credit histories once every year from the big three credit bureaus – Experian, TransUnion and Equifax – by going to AnnualCreditReport.com. In its earlier form, the new law had extended that ability to credit scores as well, offering one free look at our credit scores annually.

In the final version, however, the bill only allows consumers who are denied a loan or suffer some other sort of “adverse action” to get a free look at their credit score.

In addition to being turned down for a loan, other “adverse actions” that could result in a free look at your credit score include an increase in your cost of insurance, being charged more for, or being denied, a car lease, or if the interest rate you’re offered on a credit card or loan is higher than one being offered for those with excellent credit.

Extending fiduciary duty to stock brokers and other investment advisers

The Senate version of the bill required that stock brokers and other investment advisers act as a “fiduciary” – in other words, to put their clients interests ahead of their own.

The obvious question: if investment advisers at Wall Street firms like Merrill Lynch aren’t required to do the right thing for their clients, what have retail investors been paying them for over the last century?

As it turns out, the little guys on Main Street have been paying for a lesser standard, known in the industry as “suitability”. Investment recommendations made by retail stock brokers – often working on commission – had only to be suitable for the client, not necessarily in their best interests.

Example: Your broker calls and recommends you buy a particular mutual fund. The mutual fund would generally fit your investment profile – it’s suitable for someone with your risk tolerance, tax bracket and investment objectives.

What you don’t know, however, is they’re recommending that fund because it pays them more commission and thus costs you more in fees than other similar funds. Under the old rules of suitability, that’s OK, because the fund recommended was suitable. But not under the rules of a fiduciary, because they know there are better choices, and thus aren’t acting in your best interests.

The fact that people paid to provide you with objective advice haven’t been required to do so up to now is amazing. What’s more amazing is that Congress didn’t include this provision in the final bill. The new law instead directs the problem to be studied by the SEC for six months – then gives it the authority to change the standard.

An all-powerful consumer watchdog

One of the primary changes brought about the new law is the establishment of a Consumer Financial Protection Bureau within the Federal Reserve. This new agency will have sweeping powers to regulate virtually every kind of lending activity and lender, from the largest banks to the smallest pawn shops.

But there is one large group of lenders that escapes oversight by the new agency: car dealers.

According to Edmunds.com, of the 11 million cars expected to be sold this year, about 70% will be financed or leased through a car dealership. But despite opposition from both consumer advocates and the White House, Senate republicans successfully excluded car dealers from regulatory overview by the newly formed Consumer Financial Protection Agency.

The argument from car dealers and their lobbyists? They’re already regulated by plenty of state and federal consumer protection rules that are designed to prevent practices such as “bait and switch” lending and loans packed with undisclosed extras such as extended warranties.

In addition, dealers argued, if another layer of regulations are imposed on them, lending and leasing may become so unprofitable that many dealers would simply stop offering it, ultimately hurting consumers.

Additional Protection for investors and consumers

  • Financial literacy: The legislation requires the SEC to conduct a financial literacy study. It also creates an Office of Financial Literacy that will be tasked to develop programs to teach Americans about savings, loans, liens and fees. The agency would establish standards for financial advice programs and help keep Americans, particularly seniors, from becoming victims of scams.
  • Investor Advocate: The legislation creates an Investor Advocate within the SEC that will represent the interests of retail investors.
  • Greater disclosure to retail investors: The legislation requires that adequate disclosures be made to retail investors before they are allowed to invest in financial products.
  • More protection for underserved investors: Another goal is to allow the un-banked and under-banked greater access to mainstream financial institutions.

Other places you can learn more about the new law:

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Comments & discussion

We welcome your opinions, but let’s keep it civil. Like many businesses, we reserve the right to refuse service to anyone. In our case, that means those who communicate by name-calling, racism, using words designed to hurt others or generally acting like an uninformed bully. Also, comments that include links to email addresses or commercial websites typically aren't posted. This isn't a place to advertise your business.

  • Camile958

    Mr. Johnson, you are the best! Thank you.

  • American

    The Senate Republicans did not protect auto dealers. See here:
    http://news.firedoglake.com/2010/06/18/who-are-the-finreg-villains/

    it says that “Bill Owens, Mike McMahon and the used car salesmen: McMahon (D-NY), also part of the Ackerman initiative, and Owens have put together a letter signed by 62 House Democrats supporting the auto dealer exemption in the House version of the bill. That would exempt car dealers from oversight from the federal consumer protection agency which will either be independent or housed at the Federal Reserve. The White House strongly opposes the exemption, but it passed the House and a nonbinding “motion to instruct conferees” in the direction of the exemption passed the Senate with 60 votes. Exempting car dealers from oversight, Pat Garofalo notes, gives an unfair advantage to them over credit unions and other sources of auto financing, and exempts one of the biggest financial transactions that most people ever make.”

    Ackerman is a democrat from Queens. AND how many votes did this bill pass the Senate with – 60.

    Please research the facts before publishing erroneous information. Thank you.

  • Coktavec

    why didnt you address the unions benefits and the minority benefits in hiring practices?????

  • Veteran Loan Officer

    Camile958, and Mr./Mrs. Johnson, neither of you know what you are talking about, but especially Mr./Mrs. Johnson. This article does not mention the harm that consumers will now face with the elimination of competition to large banks.

    Ethical mortgage brokers have for years provided cost-effective financing options for borrowers purchasing and refinancing their homes. This is why Dodd and Frank had no business drafting such a ridiculous and harmful piece of garbage, a/k/a “reform” legislation.

    Eliminating yield spread premiums now requires the borrower to pay higher closing costs. Period. The choice of financing at least part of their closing costs has been taken away by idiots who have zero expertise or knowledge of how mortgage financing actually works and benefitted hundreds of thousands of borrowers each year.

    Borrowers ALWAYS had the choice of paying all closing costs out of pocket, or financing a portion of those costs in exchange for a slightly higher rate. Stacy Johnson is completely irresponsible for referring to this as “unfavorable terms” and should apologize to all of the mortgage brokers with stellar reputations for offering the most competitive and flexible options a borrower could obtain anywhere.

    “Liar loans”, or loans that could be obtained without verification of income and/or assets have been gone for at least two years. They were never a good idea and we did not need Congress to write this into law. The inclusion of this was simply for show by a group of Democrats desperately trying to hold on to their seats in Congress. Similarly, prepayment penalties on loans have fallen by the wayside years ago.

    Stacy Johnson might want to get a little more up to speed on current events before writing the next “news” article. I'd suggest the same thing to our brilliant politicians, but they aren't interested in meaningful reform, just attention-grabbing headlines.

  • Veteran Loan Officer

    Camile958, and Mr./Mrs. Johnson, neither of you know what you are talking about, but especially Mr./Mrs. Johnson. This article does not mention the harm that consumers will now face with the elimination of competition to large banks.

    Ethical mortgage brokers have for years provided cost-effective financing options for borrowers purchasing and refinancing their homes. This is why Dodd and Frank had no business drafting such a ridiculous and harmful piece of garbage, a/k/a “reform” legislation.

    Eliminating yield spread premiums now requires the borrower to pay higher closing costs. Period. The choice of financing at least part of their closing costs has been taken away by idiots who have zero expertise or knowledge of how mortgage financing actually works and benefitted hundreds of thousands of borrowers each year.

    Borrowers ALWAYS had the choice of paying all closing costs out of pocket, or financing a portion of those costs in exchange for a slightly higher rate. Stacy Johnson is completely irresponsible for referring to this as “unfavorable terms” and should apologize to all of the mortgage brokers with stellar reputations for offering the most competitive and flexible options a borrower could obtain anywhere.

    “Liar loans”, or loans that could be obtained without verification of income and/or assets have been gone for at least two years. They were never a good idea and we did not need Congress to write this into law. The inclusion of this was simply for show by a group of Democrats desperately trying to hold on to their seats in Congress. Similarly, prepayment penalties on loans have fallen by the wayside years ago.

    Stacy Johnson might want to get a little more up to speed on current events before writing the next “news” article. I'd suggest the same thing to our brilliant politicians, but they aren't interested in meaningful reform, just attention-grabbing headlines.

  • 6yearveteranmortgagebroker

    Thank you Veteran Loan Officer. I could absolutely not agree with you more. Stacy, you have exerted a great deal of ignorance if you think that eliminating YSP from a loan will help the borrower in any way or shape. Mortgage brokers that have survived this financial collapse have done so because they are honest and serve a very valuable and viable function in real estate financing. The mortgage market has corrected itself in the two years since Wall Street created it's impending doom. I personally, not have done anything but a full documentation loan in over 2 years, and this law will effectively do one thing, force the broker to join a bank. If you think eliminating competition for banks and for rates is good, perhaps Econ 101 should be a good place for your research.

    The federal government through ignorance and of course lobbying by banks, are effectively putting the responsible and honest mortgage broker out of business. Less competition means higher rates and closing costs. It is really as simple as that. What a shame that the federal government can claim to be in favor of small business, and yet put an entire industry out of business in the same breath. Not a shame, more like a bad joke.