Financial Reform: A Big Win For Consumers, a Big Loss For Investors

Last Updated Jul 1, 2010 10:21 AM EDT

Consumers won. Banks lost. That summarizes the consumer piece of the financial reform bill, which was approved by the House yesterday and awaits a Senate vote.

On the other part of the reform bill that affects individuals, my verdict flips. Investors lost, Wall Street won.

Taking the consumer side first, color me thrilled that Congress created a potentially strong Bureau of Consumer Financial Protection. When President Obama proposed it last year, I thought it a pipe dream. The bankers were too powerful, politically, and able to throw too much money around.

But the one thing more powerful than banks is voter fury -- and consumers back home were angry enough to frighten their representatives into doing a good thing.

The new bureau will oversee consumer lending products. It has the authority to force clear disclosure and fairer dealing, and block the kinds of predatory loans that fed the economic collapse.

In recent legislation, Congress addressed some of the worst depredations of the credit bubble --the cheating subprime credit cards, the lying "fixed rate" cards that weren't, the unfair interest-rate hikes on people who faithfully paid their bills. On the mortgage side, lenders have been ordered not to make loans to people who probably can't repay (what a concept!).

If it works properly, the Bureau of Consumer Financial Protection will block or modify the next generation of bad products before they can devastate family budgets. Its portfolio includes credit cards, mortgage lenders, the payday and car-title lenders whose practices can devastate lower-income workers, and lenders that might be misleading students into overusing private student loans.

The bill isn't perfect. The new bureau's budget depends partly on Congressional appropriations, which means that lawmakers could squeeze it by cutting the money it needs for enforcement. It won't be allowed to regulate auto dealers, thanks to their political clout. (I've written here about the way dealers can hide the true cost of subprime auto loans.) In certain circumstances, other, bank-friendly regulators could block the new bureau's rules.

Still, it's a huge step forward. Consumers need to stay mad, to be sure that our new financial-protection bureau -- as actually set up -- has the authority that the bill intends. Banks will try to undermine its power at every turn.

On the investor side, however, the news is bad. Voters are raging at Wall Street, too, but the issues were harder for constituents to understand. That gave the Big Money the upper hand. Here are some of the ways that your legislators sold investors out:

Congress punted on requiring stockbrokers to put their customers' interests ahead of their own, when they give financial advice. The standard of care that puts your interest first is called a "fiduciary duty." If it applied to stockbrokers, they would have to quit making recommendations based on their personal gain -- for example, by selling high-commission products when you'd be better served by products with lower fees. They'd have to tell you about the low-fee products, too.

The force with which Wall Street fought this proposal tells you a lot about the sales techniques that it relies on for its outsize profits. In a win for the brokers, the bill merely orders the Securities and Exchange Commission to make a six-month study of the idea. A finding in favor of investors will be bashed by the brokers all over again.

Congress rejected stronger regulation of equity-indexed annuities, also known as index annuities (or sometimes, misleadingly, "fixed annuities"). These products have been widely and inappropriately sold to older people. I'll have more to say about equity-indexed annuities in a future post. For now, it's enough to know that the SEC had planned to regulate them as securities and Congress said no. Instead, they'll be left to the state insurance regulators, who have let their sellers get away with murder. The states are promising to do better. Will they follow through, now that they have the SEC off their backs? Color me suspicious. When it comes to dealing with insurance companies, you need whips.

Smaller public companies gained more running room to mislead investors. After the Enron and WorldCom accounting frauds, Congress passed a law called Sarbanes-Oxley. Among other things, it required stronger audits of corporate accounting practices. "Boo-hoo," said the smaller companies, "better accounting costs too much." So Congress let them off the hook. Under this new bill, the stronger audit rules no longer apply to firms whose market capitalization is less than $75 million, which includes most of the public companies in America. Here's my take: If a company finds it too burdensome to do decent financial audits, why should you invest in it? There's more fraud in smaller companies than in large ones.

Even where the new financial-reform bill is strong, Congress and its big-money buddies will creep back to undermine it. You're seeing that right now. Originally, the largest banks -- the ones whose reckless speculation helped cause the collapse -- were supposed to pay $19 billion in fees to defray some of the costs of the financial cleanup. Massachusetts Republican Scott Brown stopped that idea dead. Instead, he is forcing the taxpayers to pick up part of the $19 billion, and banks of all sizes to pick up the rest.

The taxpayer part increases the federal deficit. Nice going, Scott. I trust that the big Massachusetts banks made it worth your while.

More on MoneyWatch:
Buyer Beware, if Auto Dealers are Exempted From Any New Consumer Protection Rules
Will Brokers Have to Put Your Interests First?
Financial Reform Bill: What Made the Cut