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End Too Big to Fail

Rein in too-risky conduct by lenders and Wall Street, and make sure

taxpayers never have to pay for another bailout

Consumers Union has called for these key elements in financial regulatory reform:

• A strong, independent consumer protection agency.
• An end to “keep the fee, pass the risk” in lending, which made it profitable to make and sell loans that borrowers were unlikely to be able to repay.
• An end to “too big to fail” by imposing effective oversight of large, interconnected, or complex financial firms that could threaten others in the financial system.
• Better day to day regulation of banks and similar financial companies and closing all regulatory gaps.

The House has already passed the Wall Street Reform and Consumer Protection Act of 2009, HR 4173, which addresses these issues.  The Senate regulatory reform bill, the Restoring American Financial Stability Act of 2010 (RAFSA), addresses these issues.

Gives consumers a strong, independent consumer financial protection regulator.  The current bank regulators are too close to the banks, and sat back while bad lending practices spread widely and harmed all of us.  We need a consumer watchdog whose only job is looking out for us, not for the banks.  That watchdog must have authority over all types of loans and bank accounts, no matter what type of business provides them.

The financial reform bill protects consumers.  The House bill includes an independent Consumer Financial Protection Agency, and the Senate bill includes an independent Consumer Financial Protection Bureau.  Both bills give the new consumer watchdog its own leadership, staff, budget, and make it directly accountable to do the job of protecting consumers in the financial services marketplace.  Read more about the CFPA at:  http://www.consumersunion.org/2009/06/cus_summary_of_the_consumer_fi.html

Reduces “keep the fee, pass the risk.”  Making bad loans was a financially rewarding practice during the mortgage boom because brokers, lenders, Wall Street loan packagers, and just about everyone who touched the loan got a fee on the deal while passing the risk of nonpayment on to the next person in the chain.  Finally, those bad loans ended up in our pension plans, and some of our neighbors lost their homes.  The financial reform bill will require that every entity that securitizes loans must keep a material portion of the risk of the loans which are packaged for sale to investors. The amount of risk retained must be at least 5% unless the loans meet regulatory standards for posing a reduced risk of nonpayment.  This is a good first step towards taking the profit out of making and selling bad loans.

Creates a new way to unwind failing big financial companies that doesn’t protect management.  There have been over 200 bank failures since the beginning of 2008.  Those failures haven’t harmed the average consumer.  That is because we already have in place a good system to “resolve,” or unwind, a failed bank.  When the FDIC takes over a bank, consumers are protected, management gets fired, and the bank is either sold or unwound in a prompt, orderly fashion.  The financial reform bill will create a process under which a panel of bankruptcy judges can decide to appoint the FDIC as the receiver of an important non-bank financial company or bank holding company.  The FDIC can fire management. Creditors and shareholders of the failed company will bear the losses, rather than the taxpayers.  If is necessary to put money into the company in order to protect innocent parties in the financial system, then that money will come from a fund paid for by assessments on other big financial companies – not from the taxpayers.

Imposes new oversight of the fiscal soundness of risky financial companies that are so big or so interconnected that they could sink the economy.  One thing we learned in the financial crisis was that the conduct of non-banks magnified the risks. Big Wall Street firms that some have called “shadow banks” lend money to banks and to non-bank financial companies.  If those “shadow banks” engage in risky practices that endanger themselves, they can also endanger the financial stability of other companies and ultimately of the entire U.S. financial system.

The financial reform bill replaces “too big to fail” for non-bank financial companies with real oversight of those big unregulated companies whose failure could harm our economy.  It creates a Financial Stability Oversight Council whose job is to monitor overall risks to the economy and to designate specific financial companies, who are not regulated now for safety and soundness, to direct regulation by the Federal Reserve Board.  That new oversight will be for non-bank financial companies that the Council determines would pose a material risk to the financial stability of the U.S. if the company were in financial distress. 

The Federal Reserve Board must establish and enforce financial soundness standards for nonbank financial companies that the Council has designated to be overseen by the Fed and also for large, interconnected bank holding companies over $50 billion in asset size.  These standards must be more stringent than for less risky bank holding companies.  The standards must increase in strictness based on: the degree of leverage of the company, the types of relationships it has with other significant financial companies; its importance to families, businesses and other borrowers; and the extent and type of any off-balance sheet exposures of the company.   The Fed’s standards must include higher capital requirements for risky activities, leverage limits, liquidity requirements, better risk management, concentration limits, and a resolution plan – that is, a plan for how to unwind the company if it should fail. 

The financial reform bill creates a process to stop too-risky activities by large, interconnected, important financial companies if those practices pose a grave threat to the financial stability of the U.S.  For big and risky bank holding companies, and for designated important non-bank financial companies, the Fed, acting with the Financial Stability Council, may require that the company stop some activities, sell assets, or comply with conditions on its activities.  This should help to reduce the risk created by these companies before it can harm the economy.

Should improve day to day bank regulation.  The financial reform bill allows the new Financial Stability Council to tell the primary regulator that it should impose higher standards for activities or practices that could increase the risk of significant liquidity or credit problems spreading in the U.S. financial markets.  The bill permits examinations of bank holding companies and their subsidiaries to determine the risks within the bank holding company.

Closes some gaps in regulation. The financial reform bill requires hedge funds to register and to disclose their trading activities, and brings over the counter derivatives out of the shadows.                              .