Senate Financial Bill Wrong for Main Street

The “Restoring American Financial Stability Act,” that passed Congress last week with 39 senators voting nay, will hurt Main Street investors and entrepreneurs, and worsen the problem of “too big to fail” bailouts. 

The numerous flaws of the bill add up to one basic problem: The bill’s omission of reform for Fannie Mae and Freddie Mac, combined with the overly broad expansion of cumbersome regulation of legitimate investors and entrepreneurs, is exactly the wrong prescription for an economy struggling to climb back from the brink.

Because of concerns my organization the Competitive Enterprise Institute and a broad array of groups addressed, however, some of the bill’s worst features were lessened or fixed. And we are hopeful that the bill’s many remaining flaws will be fixed in conference. The Senate and House bills have some sharp differences that include some ill-considered Senate amendments and some positive House provisions that were omitted.

Among the fixes that were achieved that will lessen the bill’s impact on investor and entrepreneurs and taxpayers:

1. The removal of the $50 billion “liquidation fund” funded with “assessment” fees on banks, brokerages, and insurance companies that would have been passed on to depositors, investors, and borrowers: Still intact is the major problem of prudent financial institutions being taxed after the fact to pay for the failure of their high-rolling competitors, but the moral hazard will be greatly lessened by not having a permanent bailout fund that market participants would know they could draw from if anything goes wrong.

2. The removal of rules that would have reduced dramatically the number of angel investors — wealthy investors allowed to invest in firms without SEC registration or red tape — for entrepreneurial startups: The Angel Capital Association estimated that provisions that more than doubled the threshold to qualify as an angel investor from its current level of $1 million to $2.5 million would reduce the number of angel investor by more than two-thirds. On Monday, a voice vote partially fixed the problem, but still leaves federal regulators with too much authority to shut out legitimate “accredited investors.”

3. Clarifying that the Federal Reserve only has authority over truly financial companies: On late Wednesday night, after the first cloture vote failed, the Senate passed by voice vote and amendment from Sens. David Vitter, R-La., and Mark Pryor, D-Ark., to ensure that “financial companies” that fall under the Federal Reserve’s supervision are true financial companies, and not retailers and manufacturers who tangentially expand credit. 

The amendment changes the definition from “substantially engaged” to the much tighter “predominantly engaged,” and defines “predominantly engaged” as no less than 85 percent of a firm’s revenue coming from financial activities. If it survives House-Senate conference, this important change means that Main Street companies like Home Depot or Apple would not be ensnared in the bailout fees, regulation, or seizure authority meant for systemically risky firms.

Among the most important changes needed to be made before a final bill is sent to the president:

1. Removal of the interchange fee price controls added to Senate bill that will enrich wealthy merchants at the expense of consumers: The Government Accountability Office recently confirmed that the experience with these price caps in countries like Australia shows that no retail savings are passed on to consumers in the form of lower retail prices, while retailers shift costs to consumers through higher annual fees and the reduction of rewards programs.

2. Restoration of the comprehensive audit of the Federal Reserve removed in the Senate: Like virtually every other federal agency, the Federal Reserve needs to be subject to the outside scrutiny of the Government Accountability Office. That’s why CEI and a broad array of groups on the left and right praised the comprehensive audit-the-Fed provisions that passed the House.

3. Restoration of the exemption of smaller public companies from some Sarbanes-Oxley accounting mandates: In the House, 101 Democrats joined Republicans in voting for an exemption for smaller public companies from the mandates of Sarbanes-Oxley to audit internal controls. 

These provisions of Sarbox, a law which was rammed through Congress in 2002 in response to the Enron and WorldCom scandals, have crippled the ability of smaller firms to go public and have not provided shareholders with relevant information.

4. Addition of Fannie-Freddie reform: No financial reform is complete without reining in the mortgage giants that had so much to do with the crisis. The actual enormity of holdings of subprime mortgages by GSEs during this time was not revealed until Fannie reclassified in September 2009 a large part of its prime mortgage portfolio as subprime. 

This showed that Fannie and Freddie purchase 40 percent of all private-label subprime securities. Indeed, according to housing expert Edward Pinto, housing scholar and Fannie’s former chief credit officer, millions of mortgages to borrowers with credit scores of less than 660, considered by prominent researchers to be the dividing line for subprime loans, had been labeled by Fannie and Freddie as prime going back as early as 1993.

To put a new twist on a familiar saying, “It’s never over until the House and Senate pass two identical bills to send to the president.” CEI will continue to educate policy makers about real solutions to preventing the next crisis and helping investors and entrepreneurs.