Published: May 21, 2010 11:33 AM EDT
Updated: May 21, 2010 11:33 AM EDT

WASHINGTON (AP) - Congress is getting tougher on both borrowers

and lenders blamed for inflating a housing bubble that, when it

popped, plunged the nation into a severe recession two years ago.

Under sweeping financial overhauls that have now passed the

House and Senate, home buyers won't be able to get a mortgage

without producing pay stubs or other evidence they can make their

monthly payments. A new consumer watchdog will police lenders who

offer impossible-to-resist subprime mortgages and then jack up the

interest rates to impossible-to-pay levels.

The bills, which still have to be blended into one that could

reach the president's desk this summer, also shine more light on

complex but hidden financial instruments, the "derivatives" that

made long-odds bets on whether Americans could make payments on

mortgages they never should have qualified for.

The legislation takes aim at the credit and securities markets

that collapsed when those bets turned out to be wrong, prompting

Congress and the Federal Reserve to put up more than $2 trillion to

prevent a panic that might well have triggered a global depression.

Still, for all their ambition, lawmakers left some gaping

questions on how to tackle some of the most significant financial

sector weaknesses exposed by the 2008 financial meltdown - from

mortgage giants Fannie Mae and Freddie Mac to unsettled disputes

over banks and their derivatives business and requirements that

they hold more capital. And in the rough and tumble give and take

of writing laws, they rejected tougher measures that would have

forced behemoth banks to downsize, required securitizers to retain

some credit risk in their loans, and compelled home buyers to put a

downpayment on their loans.

If anything, however, the political environment has grown more

populist since the House passed its legislation in December - a

trend that will likely protect the tougher provisions in both


Here's a broad look at elements of the bill and what they do and

don't do to avoid a repeat of a financial crisis:


In passing its sweeping rewrite of financial regulations, the

Senate does not embrace Shakespeare's admonition: "Neither a

borrower nor a lender be."

But it makes it tougher.

Mortgage brokers won't be able to make money on high interest

loans; buyers won't be able to lie about their ability to pay as

loan officers look the other way.

The Senate rejected a proposal that would have required home

buyers to place a minimum 5 percent downpayment on their mortgages.

It also rolled back a provision that would have required lenders

who sell their mortgages to hold 5 percent of the credit risk as

"skin in the game," designed to ensure they wrote safe loans.

Instead, lenders who write loans that meet strict underwriting

standards could sell their loans and avoid the risk retention


Lending would be overseen by a new agency. The House sets up a

stand-alone Consumer Financial Protection Agency with rule writing

powers. The Senate sets up an independent bureau within the Federal

Reserve and its rules could be vetoed by the oversight council of

regulators. House Financial Service Committee Chairman Barney Frank

indicated the agency would not likely end up in the Fed, but

otherwise said the authorities of the two entities were similar.

"I thought we'd have a major fight over the independence of the

CFPA," he said. "Not a problem."

Fixing the government-sponsored mortgage giants Fannie Mae and

Freddie Mac was put off for another day.

The two companies lowered their standards for borrowers during

the housing boom and now those high-risk loans are defaulting at a

record pace. The government has been forced to rescue them to the

tune of $145 billion.

Administration officials have said an overhaul of the two will

be a priority next year. And, as a Band-Aid measure, the Senate

approved a provision ordering a study, which is already under way

at Treasury.

"What we did - and I would be the first to admit it, being the

author of the provision - is fairly anemic in light of what we need

to be doing," Senate Banking Committee Chairman Christopher Dodd



The legislation creates a liquidation system for large,

interconnected firms, whereby the Federal Deposit Insurance Corp.

would step in to wind down large firms that pose a risk to the

system. Shareholders and unsecured creditors would be wiped out,

management would be fired and counterparties in their complex

transactions would not necessarily be made whole.

The Senate eliminated a $50 billion liquidation fund, prepaid by

the largest financial institutions. The House has its own fund.

Frank, no fan of the fund, said Thursday that it would come out

during a House-Senate conference on the bill.

That means that taxpayers would have to front the costs of a

liquidation. And though the Senate bill specifically says taxpayers

will suffer no loses when a large firm fails, the Senate bill gives

the FDIC up to five years to wind down a firm.

Both bills would require banks to hold more money to cover their

debts. The House bill has a specific leverage cap on financial

institutions of 15-1 debt-to-net capital ratio. The Senate requires

banks with more than $250 billion in assets to meet capital

standards at least as strict as those that apply to smaller banks.

That provision passed unanimously, but policy makers are taking a

second look, saying that standard could have unintended

consequences. It could be altered or removed in negotiations with

the House.


Both the House and the Senate require complex securities known

as derivatives to lose their unregulated status and be traded or

cleared through exchanges. That would provide a third party to help

back up the bets in the event one of the two participants in the

trade defaults. The House bill, however, grants more corporate

exceptions from regulation than the Senate bill does.

The Senate bill has a provision that would force banks to spin

off all their derivatives business. That means they would not only

be unable to make their own derivatives bets, they also could not

make derivatives markets for their clients. Bank regulators and

administration officials fear that provision could drive

derivatives into unregulated markets. They say that, too, will be

altered or removed in discussions with the House.