As if taking over health care, tripling deficits, wasting trillions on “stimulus” packages were not enough; our Federal Government has now set its sights on the financial sector with ill intent. The “Wall Street Reform and Consumer Protection Act” is now working its way through Congress and will soon be signed into law by President Obama. This Act follows the same course as health care reform where legislators have produced a bill that is more than 2000 pages long and is so far reaching that no one understands what the innumerable unintended consequences will be to our economy. Even Sen. Dodd, the bill’s chief architect, has stated that the bill’s contents, effects, and impacts are unknown and will remain so until the act is passed into law and implemented.

Consumer Financial Protection Agency

The bill creates the “Consumer Financial Protection Agency” (CFPA) ostensibly to protect Americans from unfair financial products and services with no attempt to define specific unfair practices. The CFPA will be empowered to write regulations for all entities offering financial services, including finance companies, retailers, consultants, banks and innumerable other entities. Of note, automobile financing has been exempted perhaps in view of government and union ownership of Chrysler and General Motors. Regardless, the effect of this powerful new agency will be to limit credit options, increase costs, and allow the government to determine when and if a financial arrangement is satisfactory even in private transactions between two knowledgeable and willing parties.

The CFPA will be independent, not report to Congress, and will be headed by a presidential appointee. As an apparent reward to the Trial Bar, protections in the bill also outlaw arbitration agreements in financial services, which will result in more litigation and higher costs to consumers.

Office of Financial Literacy

In perhaps the most humorous component of this dreadful Act, the bill establishes the “Office of Financial Literacy” through which the Federal Government will ensure we citizens are properly educated in finance and economics by the very people who have brought us to our current state of threatened economic collapse with their deficit spending and mounting national debt.

Too Big to Fail

In an attempt to control systemic risk yet another beurocracy is created, the “inter-agency oversight council” which will determine which firms in our financial sector are too big to fail. These firms will then be exposed to heightened scrutiny and regulation but, once they have been identified, the government will have to assume responsibility for these firms and the implied status will distort the risk profile in the market as a whole. These specific firms will be backed by a $50 billion permanent bailout fund, discussed below.

Essentially, the “too big to fail” designation will create many new Fannie Mae/Freddy Mac type entities throughout the sector and will facilitate these firms taking on even greater financial risk, as our two mortgage giants did leading up to the housing bubble deflation. Within this designation as too big to fail, the Act also facilitates private property taking by the government without due process. In an assault on Constitutionally guaranteed property rights, the Secretary of the Treasury will be able to seize any financial firm he designates as “in danger of default” with only a court review to prevent the seizure. In this type of review, evidence of condition is subject to a low judicial standard, making reversal of such a seizure order extremely unlikely.

Systemic Dissolution Fund

The bill goes on to establish a permanent bailout authority under the FDIC and sets up a $50 billion “Systemic Dissolution Fund” to secure creditors in the case of an orderly dissolution ordered by the Treasury Secretary. Creditors to be secured in such an action will be basically selected by the Secretary at the time and will not be subject to law or convention in terms of well established priorities of claims against a firm. Naturally, this provision creates a vast opportunity for corruption and payoff of constituencies as we saw during the government’s takeover of both Chrysler and GM. The cost of this fund is supposedly to be covered by fees on firms with over $50 billion in assets and by hedge funds with more than $10 billion but, of course, these fees will be passed on to consumers and will raise the cost of banking and investing for all Americans. While this is sold as a self-financing fund supported by the firms at risk, the amount of the fund is clearly insufficient (see TARP) and in the end, taxpayers will be forced once again to pay for bail outs for these firms.

Regulatory Expansion

Expansion of government regulation and consolidation of regulatory agencies in this bill will subject different size institutions to different rules, potentially adding another distortion to the competitive market for financial services. Since state and local regulations are to be left intact and companies will suffer an increased regulatory burden, passing additional costs on to consumers. Non-banks will be brought under many of these same regulations including entities which hold trusts, securities investment firms, real estate leasing companies, and manufacturers which hold customer deposits. The total cost burden and economic drag from this expansion of regulatory power is unknown and incalculable, as Sen. Dodd has pointed out.

Derivatives and Hedge Funds

The derivative marketplace is a vibrant and vital part of our economy that allows individuals and companies to stabilize their finances and to limit risk exposure to future prices, currency fluctuations, and a host of other conditions. This essential component of the economy comes under attack as well in this bill first by eliminating private swaps. All swaps will now have to go through a clearing house or electronic exchange (most already do) but now these swaps will have to receive clearance from the Securities and Exchange Commission (SEC) or the Commodities Futures Trading Commission (CFTC) before the trade or swap can occur. This will result in higher costs, delays in trading certain derivatives, limited innovation, and thus derivatives will be less widely used under this Act. The Act also dramatically encroaches on economic freedom by eliminating private derivative transactions between two knowledgeable and willing parties, as this type of transaction will no longer be allowed.

In another major transgression to our freedom, all hedge fund managers and even advisors to private pools of capital will have to register with the SEC. These same advisors will then be under the control of the government’s “Financial Stability” regulator even in cases where there is no public interest in the fund, no interstate commerce involved, and only private capital placed at risk by its owners. The rationale for the government’s interest in these funds and its right to regulate and otherwise intervene is difficult to comprehend but that right does become established in this Act.

Insurance

The “Federal Insurance Office” is another agency created under the terms of this Act with no precedent or recognized authority of Washington to interfere in the insurance industry. Insurance regulation has traditionally been left to the states but, now, the national government will intervene to mitigate insurance risk and to ensure a well functioning insurance system. This office will also be empowered to negotiate insurance issues internationally on behalf of the US. No connection with the recent financial crisis is made in the bill and there is no supporting evidence provided to justify the takeover of the insurance industry in the language of the Act.

Credit Rating Agencies

Attention to independent credit rating agencies imposes standards on these agencies that will decrease their ability to assess and rate new products and services. The Act also removes all references to credit ratings from all federal statutes and will increase costs to consumers and to financial institutions from dealing with these entities. Again, the trial bar is supported by increasing liability for rating agencies and by making it easier for individuals and institutions to be held liable for their work output by attorneys by making it easier to bring suit against these companies.

Corporate Governance

Corporate governance is addressed in the bill by giving shareholders the right to vote on executive compensation and golden parachutes. Language requires the results of these votes to be published at least annually and requires independent compensation committees be established in publicly traded companies. Any financial institution with assets over $1 billion will have to disclose all incentive based compensation structures and federal regulators will be able to prohibit “inappropriate” compensation packages. This transfers authority from boards of directors to the government on issues of compensation and vastly expands the power of the “pay czar” to companies which have no government ownership, fiduciary relationship, or bailout investment. The Government Accounting Office (GAO) will study compensation plans and determine “excessive” risk taking by financial institutions. At no time does the bill recognize the fact that investors are under no obligation to invest in any company whose compensation plan or management is structured in a way the investor might deem improper. The bill simply usurps the power to control these decisions and assigns it to the federal government. Certainly, this can be seen as a tool for unions and other activist organizations to seize control of private companies and to determine any company’s use of its fairly earned revenues and assets.

SEC and Securitization Costs

Continuing the ruse of “investor protection”, the bill will double the budget of the SEC and assign it regulatory authority over the municipal bond market, options, futures held in margin accounts, and stock loans. The bill also establishes fiduciary responsibility for all individuals and entities which offer personal investment advice, regardless of their position or qualifications. Once again, the trial lawyers will likely be the largest beneficiaries of this change as investor lawsuits against advisors, brokers, insurance agents and others will be facilitated by this change. Another component of the bill will give the SEC the ability to issue new proxy regulations regarding the naming of members of boards of directors at private, publicly traded companies. This change will allow better access to power for special interests like unions, politicians who manage pension funds, and other activist groups.

Under mortgages and securitization language, the bill will eliminate prepayment penalties from mortgages and eliminate yield vs. spread compensation plans. The net result will be to raise interest rates, increase costs to consumers, and limit innovation and consumer choice in real estate financing. Loan originators will also have to retain a minimum 5% interest in loan portfolios (qualified residential mortgages exempted) when these portfolios are sold, again limiting financing options and innovations in the marketplace. Of note is the fact that the recent housing bubble and real estate crisis was almost completely limited to the residential market and was facilitated primarily by government policy as carried out through Fannie Mae and Freddy Mac. These two quasi-government agencies now hold some 90% plus of the residential mortgage market and their willingness to purchase sub-prime loans in near unlimited quantities clearly contributed, if not caused, the real estate crisis. These two companies have received billions of dollars in bailout money and the taxpayers remain liable for billion and billions more of their debt but this Act does absolutely nothing to rectify or restructure Fannie or Freddy.

Federal Reserve

Finally, this Act makes substantial changes to the Federal Reserve through a number of provisions. The Fed retains supervision over bank holding companies and state chartered banks but also assumes policing power over inter-connected non-banks when the Financial Services Oversight Council (FSOC) deems them a threat to the economy. The Fed gains the authority, with FSOC approval to break up these companies when they recognize such a threat. In addition, the GAO gains the ability to audit the Fed’s emergency lending to financial institutions, to audit low cost loans made to banks, and to audit the sale and purchase of securities made by the Fed to set monetary policy. Thus the Fed, independent and not accountable to voters, gains significant regulatory influence and power along with a greatly expanded role in the economy. The Fed loses certain independence and some of its ability to set monetary policy by granting access to its activities to the GAO and, ultimately, to elected officials.

Summary

In summary, the “Wall Street Reform and Consumer Protection Act” would better be titled “The Government Takeover of the Financial System and Economy of the US Act”, since it will have such a far reaching impact and will so dramatically alter the way our economy functions. The American economy, operating on principles of free market capitalism, has been the envy of the world and the most successful economic model ever devised by man. The scope of this legislation will do little to correct the underlying problems behind the recent financial crisis and will have no effect on preventing any future crises. The problem was not one of inadequate regulation; the US has thousands of pages of financial regulation already on the books. The problem is really one of scale. No central planning or control will ever be as effective as a free market in creating wealth and prosperity for the people of the United States. Central planning will only increase costs, decrease innovation, and ultimately lead to the flight of capital to countries with freer and more open economies.

This attempt at takeover on such a massive scale while ignoring much of the underlying problem, including Fannie Mae and Freddy Mac, is an affront to our freedom as a people and to our Constitution. It can only be understood as the means for a control-oriented government to never let a good crisis go to waste.