Friday, July 16, 2010

The Hidden Details of Financial Reform

This is my first column for Reuters.

On its surface, the financial reform package looks tough on banks and Wall Street. Yet for individuals, the protections are much less pronounced and highly diluted.

Granted, the massive, 2,300-page-plus Dodd-Frank bill may slow down some bank failures. It may even impede avaricious trading desks from tanking the global financial system. For average investors, though, it’s a pyrrhic victory at best. Here are four major problems:

• Brokers May Not Be Reined In. The bill ordered the Securities and Exchange Commission to study requiring brokers to act in your best interest under “fiduciary” rules. The catch is, the SEC can complete its study in six months, but may not be required to impose the tougher, pro-investor standards. Industry lobbying will be fierce to get the agency to sit on, water down or squelch any decision, which is what the agency often does after any big study.
• Watch for More Credit Regulation. Mortgage brokers, student lenders and other consumer-credit firms will be subject to more oversight. There’s a new cop on the beat for consumers, although it will take months for the new Consumer Financial Protection Bureau — housed within the bank-friendly Federal Reserve — to get up and running. Look for financial services firms to pass on new fees to cover their regulatory burdens.
• It may be harder to get a mortgage. As if it wasn’t tough getting one today, Congress tightened the requirements for the “liar” loans of the bubble years, although no bank has been issuing those for some time. “No-doc” loans will not likely be making a comeback, replaced by stiffer requirements for income verification, appraisals and brokers.
• Insurers, auto dealers get a pass. Insurance agents were not even covered. Auto dealers got a “carve-out” or exemption from regulation. That means you’ll still have to be vigilant when signing up for vehicle financing — watch out for the fine print on “extras” and extended warranties.

Still, more regulation isn’t necessarily a bad thing. Credit abuses were rampant and the industry sorely needed more oversight.

How would you gauge success in the new regulatory environment? I’d love to see most credit and mortgage contracts translated into language most folks can understand. It would be a major victory if more borrowers simply understood what they are buying and could avoid trouble.

Yet some of the most pernicious issues in investor protection and megabank finance were not addressed by financial reform. The shadowy $615 trillion derivatives market wasn’t completely regulated. The banks that were too big to fail in 2008 have actually gotten bigger and the mechanism to monitor or dismember them is clunky.

For individual investors, there is no tough supervision of brokers and insurance agents selling income investments like equity-indexed insurance products, which are often oversold to older, more vulnerable investors. Insurers will still be largely policed by weak state insurance regulators.

Aggrieved securities investors are still forced to deal with the industry’s self-regulatory agency FINRA. Those who sign a brokerage agreement give up their right to sue and are mostly funneled through the industry’s captive arbitration system — yet another subject for an SEC “study.” The SEC wasn’t even allowed to finance itself and is still hostage to the Congressional appropriations process. That means it’s still on a short leash.

Another bete noire continues to be on the loose: The twin-headed monster Fannie Mae and Freddie Mac, the quasi-public mortgage entities that were seized by the government during the height of the 2008 meltdown. Estimates on fixing the two entities run up to $1 trillion. Congress did nothing in this legislation to tame this beast, which resides in a financial abyss.

Since most banks are reluctant to issue mortgages while the housing/labor market and economy are still slumping, the majority of the home-loan market was effectively nationalized two years ago. Eventually the White House must decide what to do with Fannie and Freddie since they account for about two-thirds of all new mortgages. Don’t bet on anything happening before Election Day, if it happens at all this year.

In the interim, read all of your major credit, insurance and brokerage contracts with an electron microscope to divine new hidden fees and traps. Better yet, hire a fee-only certified financial planner to read them. The only sure thing is that you’ll be seeing a lot more letters coming from your bank, broker or insurer citing higher expenses that are often veiled in “better ways of protecting yourself.” It won’t all be junk mail, so open the envelopes and protect yourself now.