In Depth on the Critical Reforms We Need

Support Strong Systemic Risk and Resolution Authority Reform
Financial Stability Improvement Act (H.R. 3996)

Why we need Systemic Risk reform:

• As the current financial crisis-driven job losses show, stable management of
systemic risk is important not only to the financial players on Wall Street, but to
every American on Main Street.
• The systemic failures that collapsed giant financial institutions last year also
compromised the economic security–the jobs, homes and retirement plans–of
millions of Americans who did not contribute to the problem.
• Regulating systemic risk is needed to ensure that the moral hazards and risk-
taking activities of a handful of firms do not threaten the broader system.
 
Key elements of strong systemic risk prevention:

• One central authority should be responsible for monitoring and stemming
potential systemic risks.
• The systemic risk regulator must have the authority to stop institutions from
creating systemic risk by growing to a certain size or complexity, becoming too
interconnected, or engaging in excessively risky activities. Particularly, it should
have authority to reinstate separations between commercial and investment
banking or limit insured depositories’ ability to engage in speculative risk-taking.
• Primary authority for systemic risk regulation may be assigned to a council of
regulators, a new agency, or the Federal Reserve. If the Fed is given authority to
oversee systemic risk, at the same time it must be made more democratic and
transparent. Without reform, the Fed will be unlikely to take necessary steps to
limit bank activity; it has designed-in conflicts of interest, with banks largely
deciding who regulates them.
• The systemic risk regulator must have staff, resources, and expertise sufficient to
monitor sources of systemic risk in institutions, products, and activities
throughout the financial markets, and it must have the power to act promptly and
independently. It also must be fully accountable and transparent to the public.
• Systemic risk and resolution authority are interconnected issues; strong
safeguards against systemic risk requires having strong resolution authority.


Why we need new resolution authority:

• Resolution authority is needed so that there is a process for failing bank holding
companies – as there currently is for conventional banks – that does not require
massive taxpayer bailouts. Currently, the Federal Deposit Insurance Corporation
(FDIC) has no authority to take distressed bank holding companies into
conservatorship or receivership. This is particularly problematic because bank
holding companies (such as Citigroup, recipient of $374 billion in government support) were the main culprits in the risky activities at the heart of the financial
crisis.
• Clearly-defined resolution authority will help limit the government’s implicit
guarantee that it will support failing institutions with taxpayer money.
. In the wake of last year’s financial failures, many institutions already considered
“too big to fail” have grown bigger by acquiring failing companies, leaving our
economy even more vulnerable.
• The Bankruptcy Code’s provisions for the distribution of the assets of a bankrupt
financial institution take no account of the systemic considerations that regulators
can and should consider.
• The status quo severely restricts the ability of the government to prevent the kind
of systemic crisis that the failure of a large, interconnected institution can cause.

Key elements of strong resolution authority:

• A sensible approach that ends the current policy of piecemeal bailouts.
• Clear language that resolution is for the purpose of systemic financial stability and
not for the purpose of rescuing failing financial companies; i.e.:

•  shareholders should recieve nothing,
•  unsecured creditors other than insured depositors or employees should the
bear losses, and
•  management and the Board of Directors responsible for the failed
condition of the company should be removed

• Assurance that to the greatest extent possible, the regulating agency responsible
for resolution act in a manner that minimizes recourse to the general fund of the
Treasury.
• Strong and clearly-defined Systemic Resolution Fund to pay for the costs
associated with the resolution process that is financed only through assessments
on financial companies and not by taxpayers. The Systemic Resolution Fund
should be funded through ongoing assessments paid by financial institutions who
pose a risk due to size or the nature of their activities.
• Systemic risk reform must be in addition to -not a substitute for- active, strong
prudential regulation.

WALL STREET REFORM AND CONSUMER PROTECTION (H.R. 4173)

Consumer Financial Protection Agency

Meaningful financial reform must make the marketplace safer for everyday Americans.

The Consumer Financial Protection Agency (CFPA) will ensure fairness and safety for
American consumers. Without it, the reform effort will fail in its current mission to save
Americans from the type of crisis through which we are presently struggling. With a
strong Consumer Financial Protection Agency, Americans can work and save to provide
for their families and generations to come. Existing bank regulators failed to design and
enforce fair rules of the road for credit, and the results include billions of dollars worth of
tricks and traps on high priced credit cards, over-limit fees on debit cards and abusive
mortgages that cost families their homes. The financial crisis demonstrates that
unchecked abuse not only hurts individual borrowers, but also undermines the whole
financial system. The CFPA will streamline government and ensure a stable and safe
marketplace. We don’t let manufacturers sell toasters that are likely to explode: we need
basic rules and protection against exploding loans, too.

AFR supports the CFPA proposal in the Financial Reform legislation, and we support
amendments to close remaining loopholes, and oppose amendments to weaken CFPA
authority. In particular, the CFPA should:

• Cover all financial products: AFR supports amendments that close loopholes
that exempt specific sectors and we oppose amendments to provide additional
loopholes. All financial products must be covered.

• Have primary examination, enforcement and rulemaking authority: AFR
opposes amendments that would split up consumer protection responsibilities
because it would weaken the agency’s effectiveness.
 
• Be a federal floor of protection, not a ceiling: AFR opposes any amendment
that would thwart the ability of states to be the first responder to local and
regional issues.
 
• Include the Community Reinvestment Act under its purview: The CFPA
must be given both rulemaking and enforcement authority for the CRA in order
for the agency to carry out its mission and to level the playing field for
underserved communities.
 
Derivatives, Hedge Funds, and Venture Capital

Transparent, regulated derivatives markets are a critical element of systemic risk
mitigation

Unregulated over-the-counter derivatives brought down AIG and fueled the housing
bubble by allowing banks to purchase inexpensive “insurance” against risky loans in lieu
of credit standards. Taxpayers bore the cost of this subsidy when $134 billion was paid
out to AIG’s counterparties. Now the 5 biggest banks dominate the derivatives market
and want to maintain the status quo, since opaque markets permit them to charge very
high fees to derivatives clients. Taxpayers, consumers of energy and other commodities,
and commercial enterprises using derivatives to hedge, are the losers.
AFR urges the House of Representatives to ensure that any legislation passed requires all
standard derivatives to trade on an exchange, providing instant price information to
market participants and regulators. This includes foreign currency derivatives. Because
derivatives market participants are “too interconnected to fail” any exception to this
policy risks rendering the legislation of little use.
Pooled investment vehicles may cause the next meltdown
Private equity funds, hedge funds, and venture capital funds are rarely stand-alone
entities; they are interconnected financial enterprises about which little is known to either
regulators or investors. The next Ponzi scheme to defraud investors could be disguised as
any of these entities, and their web of opaque and leveraged structures poses significant
risk to the US economy.

AFR supports the following elements of the House Financial Services Committee bill
applicable to hedge funds and private equity funds:

• Requires managers of hedge funds and private equity funds to register with the
SEC;

• Allows the SEC to establish record-keeping and reporting requirements;
 
• Authorizes the SEC to do periodic and special examinations.

AFR recommends that the bill be strengthened by removing the exemption for venture
capital, regulating the funds as well as their managers, and requiring public disclosure
in addition to SEC reporting.

Systemic Risk

We need both robust mechanisms for preventing undue risk and putting on the
brakes before catastrophic failure is a danger, and a system for resolving
institutions should they fail that does not leave taxpayers holding the bag.
The proposed legislation creates a council of regulators to oversee systemic risk, gives
the FDIC the authority to put failing banks into receivership, and creates a resolution
fund that large financial institutions will pay into on an ongoing basis.
AFR would support amendments to:

•  Democratize the Federal Reserve Board and prevent the banks from controlling
the regional Bank Boards.
•  Strengthen regulators ability to break up banks that are too big or too
interconnected to fail, and to prohibit dangerous activity like excessive leverage.
•  Provide the systemic risk regulator with its own staff.
•  Reinstate separations between commercial and investment banking and limit
insured depositories’ ability to engage in excessively risky activities.

AFR supports leaving in place the provisions on auditing the Federal Reserve Board
added to the legislation during mark up.

Investor Protections

The Investor Protection Act (IPA) contains a variety of measures to enhance the ability of
the Securities and Exchange Commission (SEC) to detect and prosecute fraud, including
increasing the agency’s authorized funding, strengthening its enforcement tools, and
providing new protections for whistleblowers. It also includes measures to address long
neglected gaps in investor protection. The most important of these would require brokers
who give investment advice to act in their customers’ best interests and would authorize the SEC to limit the use of mandatory arbitration clauses. The bill also strengthens the
ability of shareholders to more effectively hold management and boards accountable
from inside the company. This is a necessary, market-based complement to the external
regulatory efforts of the SEC.
AFR supports the goals of the IPA and supports changes to strengthen this title and
opposes changes that will weaken it. Specifically, the IPA should:

• Require all providers of investment advice to act in the customers’ best
interests under the fiduciary duty of the Investment Advisers Act. AFR
supports stripping FINRA (the brokerage industry’s self-regulatory organization)
of the responsibility for enforcing the fiduciary requirement for its member firms
and associated persons and opposes any amendment to further limit the scope of
the fiduciary duty.
 
• End forced arbitration. AFR opposes any weakening of this provision.
 
• Restore anti-fraud protections. AFR opposes weakening the investor
protections of the Sarbanes-Oxley Act and supports restoring requirements that all
publicly traded companies comply with Sarbanes-Oxley.
 
• Give shareholders a greater role in holding corporate boards and
management accountable. AFR opposes stripping the proxy access provisions
from the bill.

Credit Rating Agencies

Credit rating agencies, attracted by lucrative fees and virtual immunity from
accountability when their ratings failed, had given their seal of approval to financial
products whose risks they had not adequately investigated and did not fully comprehend.
Disastrously unfounded triple A ratings were key ingredients of the financial crisis; we
need credit rating agency reform.
The proposed legislation includes useful and important measures to provide for:

• Accountability, including significantly increased SEC oversight.
 
• Increased liability for credit rating agency judgments (although it does not
dramatically alter the structure of the credit rating agency system, as we believe
might be the best long term course).
 
• Universal ratings for corporate and municipal bonds.

AFR recommends that the bill be strengthened in two areas:

• Reliance on ratings. Require regulators to identify areas where laws rely on
ratings, determine whether better measures of creditworthiness are available, and
either replace or supplement the ratings as appropriate, rather than simply
eliminating reliance on ratings with no alternatives.

• Independence. Increase the independence of the oversight board and impose a
small fee on ratings engagements to fund increased oversight.

Support Strong Protection for Consumers

Consumer Financial Protection Agency Act (H.R. 3126)

Meaningful financial reform must make the marketplace safer for everyday Americans.
The Consumer Financial Protection Agency (CFPA) will ensure fairness and safety for
American consumers. Without it, the reform effort will fail in its current mission to save
Americans from the type of crisis through which we are presently struggling. With a
strong Consumer Financial Protection Agency, Americans can work and save to provide
for their families and generations to come. Existing bank regulators failed to design and
enforce fair rules of the road for credit, and the results include billions of dollars worth of
tricks and traps on high priced credit cards, over-limit fees on debit cards and abusive
mortgages that cost families their homes. The financial crisis demonstrates that
unchecked abuse not only hurts individual borrowers, but also undermines the whole
financial system. The CFPA will streamline government and ensure a stable and safe
marketplace. We don’t let manufacturers sell toasters that are likely to explode: we need
basic rules and protection against exploding loans, too.

The Consumer Financial Protection Agency Act improves federal oversight and
protection for consumer financial products. It consolidates all of the consumer protection
rule-making and enforcement functions currently spread over 17 statutes and 7 different
agencies. It reduces, streamlines and simplifies existing regulatory sprawl and ensures
that the same rules apply and are consistently enforced for all entities providing financial
products to consumers. The CFPA will improve consumer free choice by making
products easier to understand for consumers and ensuring that consumers are offered the
best available loans for which they qualify. Moreover, the CFPA will preserve the ability
of the States to address particular problems that arise within their borders, and to provide
the protections that elected state representatives deem important.
AFR supports the CFPA proposal in the Financial Reform legislation, and we support
amendments to close remaining loopholes, and oppose amendments to weaken CFPA
authority. In particular, the CFPA should:

• Cover all financial products: AFR supports amendments that close loopholes
that exempt specific sectors and we oppose amendments to provide additional
loopholes. All financial products must be covered.

• Have primary examination, enforcement and rulemaking authority: AFR
opposes amendments that would split up consumer protection responsibilities
because it would weaken the agency’s effectiveness.
 
• Be a federal floor of protection, not ceiling: AFR opposes any amendment that
would thwart the ability of states to be the first responder to local and regional
issues.
 
• Include the Community Reinvestment Act under its purview: The CFPA
must be given both rulemaking and enforcement authority for the CRA in order for the agency to carry out its mission and to level the playing field for
underserved communities.