The new banking rules to prevent another financial collapse

On Thursday, the United States Senate passed a new set of laws that will control how America’s banking industry will operate.

The rules are designed to avoid repeating an economic crisis like that faced in 2008, when the US was on the brink of economic depression. They are also designed to avoid another taxpayer bailout of any kind.

But some experts believe that although the changes may avoid another 2008 crisis, they’re not good enough to avoid any crisis. Here’s a summary of the strengths and weaknesses of the game’s new rules.

Key changes

The key changes to America’s banking rules are as follows:

• A new government ‘death panel’ can seize and orderly dissolve a major troubled bank

• A new consumer watchdog will protect consumers from bad practices by mortgage lenders and credit card companies

• Banks must keep more cash in reserve to protect themselves against potential losses

• Large banks are banned from trading using their own money (known as proprietary trading)

• Banks can’t invest more than 3% of their money into hedge funds or private equity funds

• Most trading in the risky $600 trillion derivatives market will be channelled through more open exchanges and clearing houses, and some trading must be done by separately owned companies to minimise the bank’s liability

The requirement for banks to keep more cash in reserve won’t come in for another five years so they can lend more to businesses until the economy recovers from the recession.

The crucial change that will prevent a similar collapse from 2008, however, is the new requirement for mortgage lenders to check the borrower’s income levels and credit history to make sure they can pay back the loan.

This wasn’t required from 2002 until now – hence the high number of Americans who couldn’t afford their mortgages (known as sub-prime mortgages or “liar loans”).

However, a crisis from reckless home lending is just one type of crisis. Many feel the new rules don’t go far enough in preventing a financial crisis of any kind.

Key failures

Despite having a golden window of opportunity due to widespread public resentment towards banks, American lawmakers failed to make key changes to these areas of concern:

• No clear solution to the problem of credit ratings agencies being paid by the company they’re rating

• The reasoning behind the Federal Reserve’s interest rate decisions (which over-fuelled the last boom) will not be examined

• A $19 billion rainy-day tax on banks to pay for the new system was abolished (a condition of Senator Scott Brown’s last-minute vote)

• Allowing banks to invest in hedge funds still exposes them to risks the laws are trying to avoid

• Car makers who lend people money to buy the car are exempt from the consumer watchdog, meaning their popular but reckless “no deposit, no credit check” practice will continue

• Over 200 rules remain unwritten – this will be done over the next two years by regulators (effectively ‘finance police’ like the Securities and Exchange Commission) on the specific areas they oversee

• Some of these regulators failed to stop the last crisis and many have little faith in their ability to stop the next

• Nothing of substance was done to curb the industry’s excessive executive pay culture: high pay for short-term gains but long-term risk

In the end, due to the nature of self-interested politics in Washington, Obama’s Democrats had to water the legislation down for the sake of a few key votes.

It is believed US banks and financial institutions poured $600 million into lobbying members of Congress over the past eighteen months to oppose or soften the rules.

Indeed, getting rid of the tax alone is proof of money well spent, among many other subtle but crucial amendments.

Nevertheless, the laws are certainly an improvement on the ‘anything goes’ shambles of the last decade, and much closer to a reasonable balance between responsibility and profitability.

However, success is far from certain, particularly with many of the rules yet to be made (let alone shown how they will be enforced).

President Obama is expected to sign the 2,300-page bill into law this week – his second major legislative victory following his health care overhaul in March.

But it may not yet be a victory for the American people, or the rest of the world that still relies on a healthy US economy for their own well-being.

That will be known years from now when the next economic party gets underway, and the cracks or seals in these new rules reveal themselves.

By The Casual Truth