Do Regulations Keep Your Money Safer?
Financial regulations are laws that govern banks, investment firms, and insurance companies. They protect you from financial risk and fraud. But they must be balanced with the need to allow capitalism to operate efficiently.
Why Financial Regulations Are Important
Regulations protect customers from financial fraud. These include unethical mortgages, credit cards, and other financial products.
Effective government oversight prevents excessive risk-taking by companies. Regulations would have kept the Lehman Brothers failure from catching the government off-guard.
Government protection can help some critical industries get started. Examples include the electricity and cable industries. Companies wouldn't invest in high infrastructure costs without governments to shield them. In other industries, regulations can protect small or new companies. Proper rules can foster innovation, competition, and increased consumer choice.
Regulations protect social concerns. Without them, businesses will ignore damage to the environment. They will also ignore unprofitable areas such as rural counties.
When Regulations Pose a Threat
Regulations are a problem when they inhibit the free market. It's the most efficient way to set prices. It improves corporate efficiency and lowers costs for consumers. In the 1970s, wage-price regulations distorted the market and caused stagflation.
Regulations can dampen economic growth. Companies must use their capital to comply with federal rules instead of investing in plant, equipment, and people.
Regulations aren't effective against new types of products like credit default swaps. Businesses create profitable products in unforeseen areas. Regulators keep up with the dangers these innovative products often introduce.
Some industry leaders become too cozy with their regulators. They influence them to create rules that benefit them and stifle competition.
Who Regulates the Financial Industry
There are three types of financial regulators.
Banking: Bank regulators perform four functions that maintain trust in the system. First, they examine banks' safety and soundness. Second, they make sure the bank has adequate capital. Third, they insure deposits. Fourth, they evaluate any potential threats to the entire banking system.
The Federal Deposit Insurance Corporation examines and supervises about 5,250 banks, more than half of the total system. When a bank fails, the FDIC brokers its sale to another bank and transfers depositors to the purchasing bank. The FDIC also insures savings, checking and other deposit accounts.
The Federal Reserve oversees bank holding companies, members of the Fed Banking System, and foreign bank operations in the United States. The Dodd-Frank Wall Street Reform and Consumer Protection Act strengthened the Fed's power over financial firms. If any become too big to fail, it can be turned over to Federal Reserve for supervision. The Fed is also responsible for the annual stress test of major banks.
The Office of the Comptroller of the Currency supervises all national banks and federal savings associations. It also oversees national branches of foreign banks.
The National Credit Union Administration regulates credit unions.
Financial Markets: The Securities and Exchange Commission is at the center of federal financial regulations. It maintains the standards that regulate the stock markets. It reviews corporate filing requirements. It oversees the Securities Investor Protection Corporation. The SIPC insures customers' investment accounts in case a brokerage company goes bankrupt.
The SEC also regulates investment management companies, including mutual funds. It reviews documents submitted under the Sarbanes-Oxley Act of 2002. Most important, the SEC investigates and prosecutes violations of securities laws and regulations.
The Commodity Futures Trading Commission regulates the commodities futures and swaps markets. Commodities include food, oil, and gold. The most common swaps are interest rate swaps. The unregulated use of credit default swaps helped cause the 2008 financial crisis.
The Federal Housing Finance Agency was established by the Housing and Economic Recovery Act of 2008. It supervises the secondary mortgage market. It oversees Fannie Mae, Freddie Mac, and the Federal Home Loan Bank System.
The Farm Credit Administration oversees the Farm Credit System. It's the largest U.S. farm lender.
Consumers: The Consumer Financial Protection Bureau is under the U.S. Treasury Department. It makes sure banks don't overcharge for credit cards, debit cards, and loans. It requires banks to explain risky mortgages to borrowers. Banks must also verify that borrowers have an income.
List of Major Financial Regulations
In 1933, the Glass-Steagall Act regulated banks after the 1929 stock market crash. In 1999, the Gramm-Leach-Bliley Act repealed It. The repeal allowed banks to invest in unregulated derivatives and hedge funds. They could use depositors' funds for their own gains. In return, the banks promised to invest only in low-risk securities. They said these would diversify their portfolios and reduce the risk for their customers. Instead, financial firms invested in risky derivatives to increase profit and shareholder value.
As a result, financial firms like Bear Stearns, Citigroup, and American International Group Inc. required billions in bailout funds in 2008.
The Sarbanes-Oxley Act of 2002 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.
Dodd-Frank prevents a repeat of the 2008 financial crisis. It creates an agency to review risks threatening the financial industry. It gives the Federal Reserve the authority to regulate large banks before they become "too big to fail." It regulates hedge funds, derivatives, and mortgage brokers. The Volcker Rule bans banks from owning hedge funds or using investors' funds to trade derivatives for their own profit. Dodd-Frank also created the CFPB.
How Regulations Affect the Markets
One of the arguments against regulations is that they can have unintended consequences. For example, in 2013, the Federal Reserve required big banks to add more liquid assets. That forced them to buy U.S. Treasurys bonds so they could quickly sell them if another financial crisis loomed.
As a result, the 25 largest banks increased their holdings of bonds by 88 percent between February 2013 and February 2015. The increase in demand pushed yields on long-term Treasurys down. Lower interest rates spurred lending but reduced demand for stocks. Bonds compete with the stock market for investors' dollars. Although their returns are lower, they 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 Fed's regulation means long-term bond yields may be unnaturally low. That could be one reason why the yield curve inverted in 2018.
Trump's Promise to Rollback Bank Regulations
In 2018, President Donald Trump signed the Economic Growth, Regulatory Relief, and Consumer Protection Act. It eased regulations on "small banks." These are banks with assets from $100 billion to $250 billion.
The rollback means the Fed can't designate these banks as too big to fail. They also aren't subject to the Fed's "stress tests." And they no longer have to comply with the Volcker Rule. Now banks with less than $10 billion in assets can, once again, use depositors' funds for risky investments
Trump weakened the CFPB by hiring staff who oppose it. As a result, enforcement actions have dropped by 75 percent, despite rising consumer complaints. At least 129 employees have left. Trump would like to repeal Dodd-Frank completely.
The Labor Department has delayed the fiduciary rule to July 1, 2019. It requires financial planners to keep their customers' interest first when recommending investments.
Obama Promised More Regulations
Barack Obama promised tougher regulations on insider trading during his 2008 presidential campaign. He talked about streamlining the many bank regulatory agencies. He wanted to establish an advisory group to improve transparency for financial disclosure. He also promised to crack down on trading activities that could manipulate markets.