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
"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
TOO BIG TO FAIL:
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
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.