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What Obama’s Financial Reform Proposals Mean For You

by Marc Lichtenfeld, Senior Analyst, Smart Profits Report

On Wednesday, President Obama unveiled his vision for the most comprehensive overhaul of the financial system in decades - an 88-page proposal that, among other things, includes granting the Federal Reserve more regulatory oversight.

Here are three measures that make up a large chunk of Obama’s financial reform plan - and what they could mean for you and your finances…
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  • The Consumer Financial Protection Agency: The primary function of this new regulatory body will aim to protect borrowers from mortgage fraud and unscrupulous credit practices.

Irresponsible borrowers who now find themselves underwater will get no sympathy from me. After all, if you’re borrowing hundreds of thousands of dollars, take some time to read the documents you’re signing and understand the commitment you’re getting into.

That said, there were also plenty of cases of outright fraud on the part of mortgage brokers during the boom. It’s hard to argue against stopping these practices.

Additionally, lenders will be required to keep 5% of the loans on its books rather than repackaging and selling its entire loan portfolio. This will make sure banks have some skin in the game and may think twice before lending $600,000 to the day laborer who makes $18,000 per year.

It’s also very reasonable to ask credit card companies to eliminate fine print and inform borrowers of their terms in “plain vanilla” language, as the President said.

These actions should be positive for borrowers in the future.

  • More Hedge Fund And Derivatives Regulation: Regulation of hedge funds isn’t such a bad thing. After all, just because you’re rich and a so-called “sophisticated investor” doesn’t mean you shouldn’t be afforded the same protections as any other investor.

Then again, if the SEC missed the Madoff scam when it was handed to them on a silver platter, I’m not sure what good regulating all these other hedge funds will do.

Regulation of complex derivatives makes sense, too, though I wonder how bureaucrats will be able to get their arms around these derivative instruments when most CEOs didn’t even have an idea of what kind of assets they had on their books.

These are good ideas, but are unlikely to impact the average investor very much.

  • Increased Federal Oversight: This is where it gets tricky. As I mentioned, the Obama plan aims to give the Fed more regulatory control.

I have no problem with more federal oversight of the largest financial institutions if it will help avoid the near collapse we recently experienced. Part of the reform package’s language gives the Fed “authority and accountability for consolidated supervision and regulation” of companies whose “size, leverage, and interconnectedness” could threaten the stability of the financial system if they were to fail.

I don’t believe for a minute all the conspiracy theorists, who scream that Obama wants to nationalize the banks (and everything else). And I can embrace the idea that in an emergency, the Fed can step in to take over and wind down a financial institution in an orderly fashion.

But once the government gets more power, the trend usually continues - and that makes me uncomfortable.

In a perfect world, we’d have a guarantee that the Fed simply acts as a stop-gap in the event of a crisis. Trouble is, we don’t live in a perfect world - and for that reason, giving the Fed more power to take over banks and insurance companies is a bit nerve-racking.

Over the short and intermediate-term, I suspect this won’t have a significant impact on financial stocks. But we’ve already learned the hard way that investors can’t simply stash financial stocks away in a portfolio for 20 years and collect a steady stream of income. And with potential new Fed powers, that point is driven home even more. So I’d watch those stocks in your portfolio a little more closely.

One President… Two Massive Reforms

In trying to bring about meaningful reform to two huge areas at the same time - healthcare and the financial sector - President Obama is attempting a very difficult juggling job.

And as important as it is to clean up the financial sector, it’s critical that proposed changes are thought through properly. A president or government official with a quick trigger finger in the next financial crisis has the potential to wipe out a lot of investors.

Of course, Obama’s proposal has yet to make its way through the oft-gridlocked Congress, where it could emerge in a very different form than now. In this case, that might be a good thing. While there are no easy answers here, I’m pretty sure the one that’s proposed isn’t it, particularly the part that expands the government’s power to take over financial institutions.

Over the long haul, it makes financial stocks riskier and less attractive. Just ask shareholders of General Motors.

Hoping your longs go up and your shorts go down.

Marc Lichtenfeld

Disclosure: No positions