REDRAWING REGULATORY LINES 

President Barack Obama has made banks the subject line of the populist message he is sending to Americans disgruntled by the sour economy and furious over the outsized bonuses bank executives awarded themselves  following the government bail-out of their industry.  First he called for a “financial responsibility fee” through which the largest banks would repay the government for the unrecovered costs of the financial industry bail-out.  Now he has added proposed regulations that will draw --or re-draw-- the line between core banking and investment banking activities.

Targeting the “too-big-to-fail” concerns that required the government rescue of institutions whose collapse would have threatened the financial infrastructure, Obama’s risk-control proposals would generally prohibit federally-insured depository institutions from engaging in securities trading for their own accounts and bar them from “owning, investing in or sponsoring” hedge funds and private equity groups.

These requirements, still to be flushed out in detail, would be included in the sweeping regulatory reform legislation the Obama Administration is urging Congress to enact, extending federal oversight to non-financial institutions, giving regulators the authority to dismantle “systemically important” institutions if they pose a threat to the financial system, and expanding protections for consumers (see related item on the Consumer Financial Protection Agency.) 

In addition to limiting bank securities trading activities, the proposed regulations would limit the size of depository institutions by revising an existing rule capping an institution’s market share at 10 percent of all insured deposits.  The new rule would add other liabilities to that 10 percent calculation.

 “Never again will the American taxpayer be held hostage by a bank that is too big to fail,” President Obama said in announcing his risk-reduction plan.  “Too many financial institutions have put taxpayer money at risk by operating hedge funds and private equity funds and making riskier investments to reap a quick reward.  And these firms,” the President continued “have taken their risks while benefiting from special financial privileges that are reserved only for banks.”

The proposed restrictions on bank activities specifically target the investments in mortgage- backed securities and other “high-risk” investments that some industry analysts believe helped push banks and the economy to the financial brink.  “When banks benefit from the safety net that taxpayers provide,” President Obama said, “it is not appropriate for them to turn around and use that cheap money to trade for profit.” 

The plan the President outlined represents a victory for Paul Volcker, chairman of the White House Economic Recovery Advisory Board, who has been arguing insistently for stronger controls than Treasury Secretary Timothy Geithner and Lawrence Summers, director of the White House National Economic Council, have supported.  Geithner and Summers have insisted that increasing capital requirements would be the most effective and most desirable means of controlling bank risks, and until recently, that view prevailed. 

But as a more populist, anti-bank message has resonated with voters, Volcker’s argument, that stricter limits on bank activities are needed to control “unmanageable conflicts of interest,” have gained the upper hand.  Volcker and others have endorsed restrictions similar to the Glass-Steagall Act barriers between banking and commercial activities that were imposed after the Depression but erased by the 1999 Gramm-Leach-Bliley Act, which scaled back banking industry regulations. 

While the limits on risk and growth the Obama Administration is proposing do not fully restore the Glass-Steagall Act, they clearly invoke its underlying assumption that taxpayer money, now in the form of federal deposit insurance, should not support activities unrelated to the “core” bank functions of accepting deposits and making loans for individuals and businesses.  

The proposal has encountered predictable opposition from the banking industry, and something less than a ringing endorsement from Congressional leaders.  While Rep. Barney Frank (D-MA), chairman of the House Financial Services Committee, has expressed general support for the President’s plan, he has also suggested that parts of it should be phased in over several years to avoid flooding the market with hedge funds and other assets bans might be required to divest.

Sen. Christopher Dodd (D-CT), chairman of the Senate Banking Committee, has been more critical, warning that the proposal will complicate Senate efforts to enact a regulatory reform bill.  “It’s adding to the problems of trying to get a bill done,” he said following a recent Banking Committee hearing at which Volcker testified.  Suggesting that the Administration may be overreaching, Dodd added, “I don’t want to be in a position where we end up doing nothing because we tried to do too much.”  �

CFPA:  THE SAGA CONTINUES

Following the debate over the Consumer Financial Protection Agency (CFPA) is a bit like watching an old-fashioned suspense flick, filled with perils and unexpected twists that leave viewers on the edge of their seats, uncertain about where the story will go next or how it will end.  Here’s the summary of the plot thus far: 

The House included the CFPA as the stand-alone agency the Obama Administration is seeking in the reform bill approved last year, overcoming stiff banking industry opposition that succeeded in diluting the measure, but not in eliminating it.  On the Senate side, under pressure from Democrats and Republican members of the Senate Banking Committee, chairman Christopher Dodd (D-CT) abandoned the go-it-alone bill he was drafting and  enlisted the committee’s ranking member, Richard Shelby (R-AL) in a highly-publicized effort to forge bipartisan agreements on contentious provisions, the CFPA primary among them. After weeks of meetings, punctuated by periodic assertions that negotiators were making steady progress, Dodd announced that the discussions had reached an impasse, forcing him to proceed without Republican input. 

“While I still hope we will ultimately have a consensus package,” he said in a press statement, “it is time to move this process forward.”

But less than a week later, Dodd announced that another Republican member of the committee, Sen. Bob Corker (R-TN), was willing to continue working on a bipartisan compromise. Corker, who had been paired with Sen. Mark Warner (D-VA) on one of the bi-partisan banking committee teams trying to hammer out agreements on key issues, said he was stepping up because he believes a bipartisan regulatory reform bill is both possible and essential.  But Corker also indicated that he does not necessarily have the enthusiastic support of his party’s leaders.  “I am stepping forward purely as one Republican Senator,” he told reporters.  The freshman legislator also made it clear that the CFPA is not one of the issues on which he is willing to bend. 

“Like most Republicans, I believe a stand-alone agency for consumer protection or separating those protections from safety and soundness are non-starters,” he told reporters. While noting his willingness to seek a solution that “enhances consumer protection without negatively impacting the safety and soundness of our financial system,” Corker said, “If we cannot [accomplish that goal], this will not be a bill I can support.” 

During the negotiations with Shelby, Dodd had indicated his willingness to jettison the stand-alone CFPA in favor of a proposal that would make it part of another regulatory agency or establish it as a division of the Treasury Department.  The negotiations with Shelby reportedly broke down because the legislators could not agree on how much power the entity would have, with Dodd insisting that it have rule-making authority and Shelby adamant that consumer protection not override safety and soundness or even equal it in the balance. 

Corker has indicated that he pretty much agrees with Shelby on that point.  “What you can’t have is consumer protection trumping the safety and soundness of our financial institutions,” he told American Banker.  “I think there’s a strong desire to seek a balance there and work it out in a way that is appropriate.”

Corker has suggested that negotiators set CFPA aside for now “and figure out things we agree on first.”  But even if Banking Committee negotiators are willing to put the CFPA on hold, proponents and opponents of the measure continue to slug it out in the media. 

The issue appears to have divided the business community, with the U.S. Chamber of Commerce spending millions on an advertising campaign opposing the agency, while groups representing small businesses are publicly supporting it.  Submitting a letter signed by more than 200 small business owners, the American Sustainable Business Council urged Congress to overcome partisanship, resist the lobbying of large banks opposing the CFPA, and establish it as a strong, independent agency.  Business for Shared Prosperity, another small business group, agreed that an independent CFPA is needed “to promote financial product safety, establish clear, enforceable rules of the road…and help ensure we do not repeat the reckless practices we are dearly paying for today.” 

Elizabeth Warren, the Harvard Law Professor who proposed the CFPA and is the most likely candidate to lead it, has  identified  the outcome of the CFPA debate as a marker for the effectiveness of regulatory reform and the seriousness of lawmakers about achieving it.  In a letter to “friends,” Warren, said that what happens to the CFPA proposal will determine “whether we are going to let the [banking] industry continue to write the rules ¾ to keep the cops off the beat ¾ or whether the financial crisis is actually changing something. The next few weeks,” she said, “will determine whether families will have to play by rules written by the banks and for the banks ¾ rules that let the industry get away with anything.  In my view, we cannot let families lose again.”

While some industry analysts think the resumption of bipartisan negotiations will improve the prospects for Senate approval of a regulatory reform bill that includes the CFPA, in some form, others suggest the opposite conclusion, expressed by an unidentified lobbyist, who told CongressDaily:  “Ultimately, Republicans have no incentive to help a lame-duck chairman (Dodd, who is not running for re-election) pass a bill their business supporters hate.  But Republicans don’t want to be branded as anti-reform,” this lobbyist added. “So the best strategic option for Republicans is to continue negotiating with the expectation that the bill will die of its own weight.”  � 

CREDIT CARD CONFUSION

Consumers appear to be almost as confused about the details of the new credit card protections that take effect later this month as they are angry about the industry practices that triggered them.  A survey commissioned jointly by the Credit Union National Association (CUNA) and the Consumer Federation of America found that while more than 60 percent of consumers are aware that Congress has mandated new protections, 65 percent don’t know the new rules take effect this month and don’t understand what they entail. 

More than one third (35 percent) of the respondents assume incorrectly that the new law caps late fees at $35, 31 percent assume (also incorrectly) that the law imposes a 20 percent cap on rates, and 42 percent think the law prohibits issuers from increasing the rate on one card because of the payment history on another card (the law requires advance notice of such changes, but does not prohibit them).  

While many consumers think the law provides protections it does not offer, others are unaware of the protections that are included, with fewer than half aware of the provisions requiring card companies to apply monthly payments to higher-interest debt first and barring over-limit fees unless consumers authorize over-limit transactions. 

“We are especially concerned that some consumers will base their future credit card use on protections that don’t exist,” Stephen Brobeck, executive director of the CFA, said in a press statement. 

More encouraging, Brobeck said, were indications that consumers are responding appropriately to adverse changes in their credit card rates or terms, by using their cards less frequently, repaying balances more quickly, or halting use of the cards entirely.  More than half of the respondents indicated they have received notice of a change in their credit card terms since Congress approved the new credit card protections. 

“The new rules are leading to changed behavior” by card companies, Bill Hampel, CUNA’s chief economist said.  “Considering all the credit card mailings they typically receive and the complexity of some of these disclosures, it’s a positive sign that many consumers have noticed the changes,” Hampel added, and a positive sign that many are responding by changing their use of the cards or shopping for better deals.  “Our data show more consumers are turning to credit unions’ credit cards, which typically offer lower rates and compare more favorably than other issuers’ cards,” Hampel said.   

DPA Redux?

Remember the Federal Housing Administration’s seller-funded down payment assistance program (DPA) — a program Congress axed in 2008 at the FHA’s request, because of the outsized losses associated with it?  In a move viewed by some (including FHA officials) as counterintuitive, a few lawmakers are now backing legislation that would reinstate it. 

Under the program, sellers contributed the buyer’s down payment indirectly by making a contribution to a third-party nonprofit that, in turn, “gifted” that amount to the borrower. But DPA loans, which represented only about 10 percent of the loans the FHA insured last year, accounted for more than 30 percent of the agency’s losses. Agency officials calculated that 13 percent of DPA loans defaulted in 2004 compared with only 4 percent for FHA borrowers generally.  Those statistics and agency estimates that DPA losses would drain more than $10 billion from the FHA’s already seriously depleted reserves, persuaded Congress to eliminate the program.

Still, the program remains popular with home builders (who relied heavily on it during the boom), with local governments and with many members of Congress.  Rep. Al Green (D-TX) has introduced legislation that would reinstate the program, with provisions strengthening the appraisal requirements that, he says, will prevent the abuses and correct the underwriting weaknesses responsible for the poor loss performance.  The legislation, which has 22 co-sponsors, is supported by, among others, the Congressional Black Caucus, the Congressional Hispanic Caucus and the Mayor’s Conference. All credit the program with expanding home ownership opportunities for lower-income borrowers and say it is especially important today to support the weak housing market. 

But the program’s critics insist that it does far more harm than good.  Former IRS Commissioner Mark Everson called the program “a sham” and Lawrence Yun, chief economist for the National Association of Realtors, has warned that it artificially inflates home prices.  “It is not a real arms length transaction,” he said of DPA loans.  “There is too much temptation for the seller to just increase the price to cover the [down payment] contribution.”

FHA officials also remain adamantly opposed to resurrecting the program.  “We’ll always listen to proposal,” FHA Commissioner David Stevens told Business Week recently.  “But [HUD Secretary Shaun] Donovan has been absolutely clear that he’s against the idea, and so am I.” �

AGREEMENT ON PRINCIPAL

Long blamed for refusing to accept the losses required to restructure mortgages for struggling homeowners, some investors are now joining forces with consumer advocates in arguing that principal reductions are essential to make serious headway against rising foreclosures.  With more than 20 percent of all homeowners underwater (holding loans that exceed the value of their homes) and 7.1 million of the 7.9 million borrowers currently in default believed to be at serious risk of foreclosure, “Principal reduction is the only answer,” Laurie Goodman, senior managing director at Amherst Securities Group, told the Wall street Journal. 

Industry executives now promoting principal reductions point out that holders of mortgage securities have already been forced to mark them down to reflect depressed values; principal reductions, they say, probably would not require any further reductions.  Financial institutions, which have also resisted principal reductions, are also beginning to look more favorably on that option, according to a recent Wall Street Journal article.  “Everybody’s realizing there is a place for principal reductions to a much greater extent than before,” Jack Schakett, a senior executive in the bank’s workout department, told the publication. 

Critics of the Obama Administration’s Home Affordable Mortgage Program (HAMP) say its failure to allow principal reductions (or require them) is a serious and possibly critical flaw in the Administration’s flagship foreclosure prevention initiative.  That is among the changes the State Foreclosure Working Group recommends in a recent report criticizing HAMP’s slow progress in modifying loans for struggling borrowers.  The task force, including attorneys general from 12 states, bank regulators from New York City, North Carolina and Maryland and the Conference of State Bank Supervisors, suggested that principal reductions should be required for eligible HAMP borrowers in areas struggling with “significant” declines in home values.