Do Regulations Keep Your Money Safer?
Federal financial regulations are national rules and laws that govern banks, investment firms, and insurance companies. They protect you from financial risk and fraud.
In the 1980s, the federal government began deregulating. It wanted to allow U.S. banks to be stronger global competitors. That created a bigger a problem. Foreign countries blamed the lax U.S. banking regulations for the 2008 financial crisis. In November 2008, the Group of 20, also known as G-20, called on Washington to increase regulation of hedge funds and other financial firms. By then, it was too late.
The Dodd-Frank Wall Street Reform Act
In 2010, Senator Frank Dodd and Congressman Barney Frank finally pushed through bank reform. Their act requires banks to increase their capital cushion. It gives the Federal Reserve the authority to split up large banks so they don't become "too big to fail." It eliminates loopholes for hedge funds, derivatives, and mortgage brokers. The "Volcker Rule" bans Wall Street banks from owning hedge funds or using investors' funds to trade derivatives for their profit.
Dodd-Frank set up a Consumer Financial Protection Agency under the U.S. Treasury Department. This gives states the right to regulate banks and the ability to override federal regulations for the public’s protection. It also recommends an independent agency with the authority to review systematic risks affecting the entire financial industry. It reduces executive pay by giving shareholders a nonbinding vote. The Agency was originally proposed in 2009. The bank lobby prevented it. The Dodd-Frank Wall Street Reform Act contains eight components designed to prevent a devastating financial crisis similar to that of 2008.
Regulations in 2013
In the fall of 2013, the Federal Reserve required big banks to add more liquid assets. That meant they needed assets, like Treasurys and other government-backed bonds, they could quickly sell for cash if another financial crisis loomed. This increased liquidity had another effect. The 25 largest banks increased their holdings of these bonds by 88 percent between February 2013 and February 2015. That pushed yields on long-term Treasurys down, even though the economy was getting better and the stock market was booming.
Bonds affect the stock market by being its competition. Although the returns on these are lower, bonds compete with stocks for investors’ money because these investments offer more security.
The Fed's requirement also reduced liquidity in the bond market itself. Many banks held onto bonds instead of buying and selling them. That made it harder to find buyers when needed. Reduced liquidity like this could have contributed to the bond flash crash in 2014. The could make a bond market collapse more likely. At the same time, it reduces the likelihood of any particular bank failing.
How Regulations Prevent Another Crisis
These regulations would have prevented failures like Lehman Brothers from catching the economy and the government off-guard. They protect consumers from unethical mortgage and credit card offers.
Regulations cannot prevent the kind of innovation that created products like credit default swaps. Businesses create profitable products in unforeseen areas. Regulators cannot, and should not, stop this innovation. It is up to individuals to inform themselves and stay alert when making financial decisions.
Obama Promised to Do Even More
In his 2008 campaign, Barack Obama promised tougher regulations on insider trading. He wanted to streamline regulatory agencies, especially those that oversee banks that borrow from the government. He wanted to establish a financial market advisory group, improve transparency for financial disclosure, and crack down on trading activities that could manipulate markets.
Once elected, President Obama put together an economic team that supported more federal regulations. Obama appointed former Federal Reserve Chairman Paul Volcker to head his Economic Recovery Advisory Panel. Volcker blamed the economic crisis on poor regulation of the financial sector. He is a well-known advocate of tougher restrictions.
The Securities and Exchange Commission is at the center of federal financial regulations. President Obama appointed Mary Schapiro as the chair. She was another advocate for increased regulation. One of the first things she did was to increase the regulations on the SEC itself.
The Federal Reserve took control of companies that were too big to fail, like the American International Group Inc. The Federal Deposit Insurance Corporation is in charge of winding down commercial banks before they go bankrupt. But these agencies didn't cover hedge funds and mortgage brokers.
In 2002, Congress passed the Sarbanes-Oxley Act. It was a regulatory reaction to the corporate scandals at Enron, WorldCom, and Arthur Anderson. Sarbanes-Oxley required top executives to personally certify corporate accounts. If fraud was uncovered, these executives could face criminal penalties. At the time, many were afraid this regulation would deter qualified managers from seeking top positions.
In 1999, Congress repealed the Glass-Steagall Act. The repeal allowed commercial banks to invest in derivatives and hedge funds. It also allowed investment banks to take deposits. It signaled a shift toward allowing the market to regulate itself. As a result, firms like Citigroup invested in credit default swaps. These firms required billions in bailout funds in 2008.