Currently, consumer protection for various financial products, such as credit cards and mortgages, falls to different groups. The Restoring American Financial Stability Act of 2010 (RAFS), signed into law by President Barack Obama this week, changes all that.
The legislation unites various groups under one umbrella, the Consumer Financial Protection Bureau (CFPB), which will be housed within the Federal Reserve System. The main purpose of the CFPB will be to oversee several laws, including the Electronic Funds Transfer Act, the Truth in Lending Act, the Fair Debt Collection Practices Act, and various other laws that govern mortgages and real estate transactions.
Is it a good idea to concentrate so much power in one agency? It depends on who you ask. The Christian Science Monitor likens the CFPB to the creation of the Department of Homeland Security, which bundled law enforcement under one roof. Others say the CFPB is overkill, protecting consumers from themselves.
One aspect of the bureau’s power that has drawn a great deal of criticism is that it will be able to write and enforce new laws to govern banks and credit unions having at least $10 billion in assets, large nonbank financial companies, and other nonbank mortgage companies. Certain professions – including real estate agents, attorneys, accountants, and many retailers – would be exempt. Some believe this level of power could be used to harm small business.
Following are some of the specific areas that will be affected.
The major change to mortgages is aimed at helping consumers avoid buying houses they can’t afford – or at least making it harder to get low-quality loans, such as the notorious subprime mortgages. Lenders not only will have to get better documentation of the borrower’s income, but they will also have to determine the borrower’s ability to make the payments. In addition:
- Prepayment penalties will not be allowed for most mortgage loans.
- Certain incentives will disappear. Until now, lenders could offer incentives, or yield spread premiums, to mortgage brokers who succeeded in originating loans that included high interest rates when the borrower qualified for lower rates.
While there is an obvious upside to some of these protections, there also is a downside. Mortgages will be less profitable for lenders; therefore lenders likely will make it tougher to qualify. Many lenders already have tightened up the eligibility standards and are requiring higher down payments.
As might be expected, analysts from both sides – consumer protection and the mortgage industry – view the new bill differently. Some feel that lax oversight by several different agencies caused the subprime fiasco.
“The existing regulatory agencies really care more about the safety and soundness of banks. That’s why it’s so important that something be set down to really help people in the end see these products coming along,” Linda Sherry, director of National Priorities for Consumer Action, told reporters.
Sherry cited interest-only mortgages, which reset to higher interest rates, as an example of bad loans. The CFPB, she said, will prevent those loans, or permit them only with hefty warnings.
From the banking perspective, eliminating or limiting certain mortgage products is detrimental for consumers.
“Every one of these types of mortgage vehicles was good for someone,” Wayne Abernathy, executive vice president of financial institution policy for the American Bankers Association, told reporters. “They were only bad when they became used for the wrong people.”
For people with income that fluctuates month-to-month, an interest-only loan allows them to skip payments in some months, he said. Increased regulation translates to less choice for consumers.
Abernathy predicts that consumer bank fees will increase and the level of services available will decrease. With so many added rules to follow, banks will have to hire more people just to ensure they are in compliance. Ultimately, said Abernathy, small banks will be forced to close under the weight of the higher costs of doing business. Once again, that means less consumer choice.
So far, it remains unclear if the rules that govern other loans will affect car loans.
“The auto finance industry is very centered on how they can get as much out of you on the loan, because the profit margin on a car is very slim for an auto dealer. It’s a large area of consumer finance that has a lot of tricks and traps in it that needs to be regulated at the federal level,” Sherry said.
A boon for small, publicly traded businesses
One bright spot for small business centers on The Sarbanes-Oxley Act (SOX). SOX 404(b), the audit requirement for public companies (defined as those under $75 million in market caps), is eliminated by RAFS. This exemption is permanent, and means that qualifying companies will no longer have to comply with the onerous burden of having an independent auditor verify the effectiveness of their financial reporting controls.
“Obviously, our smaller reporting company clients are excited about this exemption, particularly those with June 30, 2010, year ends, who were up first,” said Sharlyn Turner, partner at Seattle-based Peterson Sullivan LLP. “While this provides relief with respect to the audit burden, we caution our clients and other smaller reporting companies not to lose sight of the 404(a) requirements which still apply in full force. Management needs to continue doing their own assessment, testing, and reporting on the effectiveness of their internal controls over financial reporting, and auditors will continue to review management’s assessment and testing as part of the year-end audit.”
In other words, SOX is a two-part law. Section 404(a) requires that company management assess and report on the effectiveness of its financial reporting internal controls, whereas 404(b) requires that an independent auditor attest to the effectiveness of those controls. For many companies, the cost of this compliance was a crippling burden. RAFS exempts small companies from the 404(b) requirement, but not from 404(a).
Companies which fall under the accelerated filer designation (public companies with market caps between $75 million and $250 million) might also see a future benefit under RAFS. Under this law, the U.S. Securities and Exchange Commission will be examining the possibility of reducing 404(b) compliance on mid-market companies as a way to encourage these companies to list on the U.S. stock exchanges.
Some Wall Street effects
As debate wore on about the final form this new law would take, there has been much talk about Wall Street getting raked over the coals. Here are two rule-making procedures that will be used to govern the making and enforcement of new regulations for this area of the economy:
- A weakened version of the Volcker rule, which restricts banks from making certain types of speculative investments. Had this rule been in effect earlier, banks that accepted federally guaranteed deposits would have been prevented from proprietary trading (with exceptions). The rule also would have severely limited bank holding of alternative investments such as private equity funds and hedge funds.
- Derivatives. Banks will be required to segregate their derivative trading into a separately capitalized subsidiary, with significant exclusions. Derivatives that must be separately traded include equity derivatives, commodity swaps, and non-investment grade derivatives. Trading in certain derivatives will be allowed to continue, including foreign exchange derivatives, interest-rate swaps, and investment grade credit default swaps.