The Worst Thing About the Financial Reform Bill

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by: Tom Brown

Banking executives like Jamie Dimon are trying to reconcile themselves to the inevitability of the financial reform bill by saying they “agree with 80%” of what’s in it. He seems to think that that ought to count as good enough, and is the best that can reasonably be hoped for, in any event.

Jamie! It’s a 1,400-page bill! Twenty percent of 1,400 works out 280 pages of what are, even you seem to admit by implication, some pretty dumb ideas. The proposed, do-goodish, Consumer Financial Protection Agency, for example would have the effect of restricting the flow of credit of consumers and making it more expensive. How that’s supposed to benefit consumers, I don’t know. The requirement that lenders retain at least a 5% interest in loans they securitize figures to backfire from an accounting standpoint, and might squash the securitization market. And the Volcker rule and the Lincoln amendment, which each curtails banks’ ability to trade for their own accounts, would make financial institutions less stable by restricting their ability to hedge their risks.

Any of these provisions are bad enough to merit opposing the entire bill, in my view. In the meantime, the 80% that’s said to be unobjectionable still isn’t all that great. For example, the bill doesn’t include provisions that would, say, prevent a re-run of the chaos that followed Lehman’s (OTC:LEHMQ) collapse in September of 2008, should some similar collapse occur in the future. Nor does it reform regulation of the basic cause of the whole mess: mortgage lending. Fannie (FNM) and Freddie (FRE) will retain their oddball public-private status.

But maybe the worst part of the bill is one that few people seem to be talking about: its lack of preemption of state law regulating financial serves companies.

It could lead to chaos. Under the new law, large banks won’t just have to comply with federal rules and regulations (including ones put forth by this misbegotten CFPA), they’ll have to comply with the rules and regs of each and every state they operate in. It will be a nightmare of duplication and useless paperwork. Borrowers are the ones who will lose out in the end.

Take, for instance, what’s likely to happen in the mortgage lending. In the aftermath of the housing crackup, most states won’t be able to resist the temptation to “crack down” on mortgage lenders by enacting new laws to regulate them. Some states might outlaw, say, option ARMs or no-doc loans. Others might introduce new licensing requirements. Or minimum downpayment or disclosure requirements.

On an individual basis, each of the rules might be sensible. But how is a large national lender supposed to keep track of them all and assure compliance in each and every state? Faced with the added expense and potential penalties, lenders will either a) reduce the breadth of their product line down to a few, plain-vanilla offerings, b) withdraw from certain markets outright, or c) both. Translation: credit availability to consumers will go down while its cost goes up.

And for what? What purpose will be served by adding a redundant layer of state regulation on top of federal regulation? It’s not as if the mortgage lending business is so different in Oregon is so different than it is in, say, Delaware that regulation is best left to local officials. Just the reverse. Mortgage lending has shown itself to be a national business over the past few decades, as a handful of banks have emerged to dominate the business. And now those companies are going to have to ensure they’re in compliance with 50 different sets of rules plus what the feds require? That’s crazy.

In card lending, the problem will be the same except perhaps worse. (Lawmakers seem to especially love to tee off on card lenders). Auto lenders, as well. As I say, none of this will make consumer credit cheaper or more plentiful.

I’m at a loss to understand why so many people in Congress believe this bill will help consumers and stabilize the financial system. It will do just the opposite. One of the main reasons why is the regulatory chaose the bill’s lack of preemption will unleash.

Disclosure: No positions