WASHINGTON — With final Senate passage Thursday of the broadest overhaul of financial regulation since the Great Depression, the hard work really starts. The legislation will bring lots of changes. Here are some answers to questions about them, and how it will address some root causes of the deep financial crisis.
Q: What does the legislation do for ordinary people?
A: The most significant change is the creation of a Bureau of Consumer Financial Protection, which will be independent but housed in the Federal Reserve, the nation's central bank. This new agency will have a single mission: consumer protection for credit products, such as mortgages and credit cards.
Q: What does that mean for home buyers?
A: The law includes a number of provisions that restrict predatory lending. The question is how aggressively the new bureau oversees mortgage lending. For example, will it set ironclad limits on "liar loans," in which there was no income verification for mortgages? Will it ban adjustable-rate mortgages with low teaser rates that allowed borrowers to get into homes they couldn't afford?
Another important change is tough regulation for mortgage brokers. Many borrowers erroneously assumed that these brokers had their best interests at heart. Instead,lenders rewarded many brokers for getting borrowers into ill-suited mortgages.
To the ire of consumer advocates, the new agency will have only limited power over auto lending.
Q: How does this legislation fix what went wrong?
A: Various federal regulators will sit together on a "systemic risk" council that will police threats to the entire financial system. They'll also get "resolution authority" that allows them to deconstruct a failing large financial firm in orderly fashion.
During the crisis, bankruptcy was the only option. That would have pitted creditors against shareholders and created panic. The Bush administration orchestrated the fire sale of investment bank Bear Stearns in March 2008, preventing panic. It tried to do the same with Lehman Brothers in September 2008; when that failed, Lehman went bankrupt.
The ensuing panic nearly caused the collapse of global finance. That was prevented only by a massive government bailout program that was unpopular with voters, and by the Federal Reserve's direct intervention in financial markets.
Q: The legislation doesn't fix Fannie Mae and Freddie Mac. Weren't they a cause of the crisis?
A: Yes. The two mortgage finance giants, now in government conservatorship, certainly were contributing factors to the financial crisis. The Obama administration and congressional Democrats opted to leave Fannie and Freddie out of the bill, ostensibly to address them separately once the housing market recovers.
Fannie and Freddie buy mortgages originated by banks, then bundle them for sale to investors as bonds. From 2000 to 2006, Wall Street banks jumped aggressively into this business and out-competed Fannie and Freddie. In 2007, these Wall Street bonds backed by pools of U.S. mortgages began blowing up, and on came the financial meltdown.
Q: Will the bill prevent financial crises?
A: Probably not. The legislation mostly fights the previous crisis, not the next one, and Wall Street always finds innovative new ways to make markets spin.