WASHINGTON — The revamp of financial regulation that was agreed to Friday and is going to a vote in both houses of Congress next week addresses head-on much of what brought about the financial crisis:
- Mortgage and predatory lending. Numerous federal regulators lose consumer protection powers to a new Bureau of Consumer Financial Protection, which has the consumer as its sole focus. The bill contains numerous measures to halt predatory lending, bans mortgages without proof of income documentation, brings mortgage brokers under regulation and reins in subprime lending. It doesn't address mortgage finance titans Fannie Mae and Freddie Mac, now in government conservatorship.
- Risk retention. After lenders made bad loans, the loans were sold into a secondary market where they were pooled with others and sold to investors as complex mortgage bonds. The risk associated with a bad loan were passed along to unsuspecting investors. The bill requires lenders to retain 5 percent of the risk, effectively giving them skin in the game. Banks sought an exemption for safer products such as 30-year fixed mortgages, but were rebuffed.
- Credit rating agencies. Before the mortgage bonds could be sold to unsuspecting investors, they needed investment-grade ratings. A McClatchy investigation last year revealed that Moody's Investors Service and other ratings agencies were in bed with Wall Street. The legislation directs regulators to establish a process by which issuers of complex bonds no longer can choose who rates their products. It also directs government agencies and pension funds to rely less on ratings as a measure of risk.
- Derivatives and credit-default swaps. These insurance-like products amplified the financial crisis because it was unclear who owed what to whom. Most of these complex bets weren't settled on any exchange or clearinghouse, and most will be now. Banks will have to spin off their trading desks for operations that involve betting on the future prices of oil, most metals and agricultural commodities. Banks may bet only on the performance of investment-grade debt; other such bets must be made through affiliates. The legislation doesn't address the so-called "naked swaps," in which Wall Street firms bet on default for debt they don't own, raising volatility and borrowing costs.
- Resolution authority and "too big to fail." When sinking home prices sparked rising defaults on mortgage bonds, concerns about credit-default swaps written on these bonds spread panic on Wall Street. Regulators lacked the power to step in and dissolve sagging investment giants such as Bear Stearns and Lehman Brothers. The legislation gives new breakup authority, so the Federal Reserve will be able to step in and order a large financial firm such as an American International Group to shed some of its assets if it's considered so large that its failure would threaten the broader financial system. AIG was considered too big and interconnected to fail, and it received $182 billion in taxpayer and government life support.
- Heads I win, tails you lose. The legislation prohibits commercial banks from engaging in trading on their own behalf if they also trade on behalf of clients. Banks will have up to seven years to spin off these so-called proprietary trading arms. A McClatchy investigation of Goldman Sachs last year, confirmed by legal action the Securities and Exchange Commission took in April, revealed how Goldman had sold clients mortgage bonds at the same time it was betting against the mortgage market.
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