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FACT SHEET: Financial regulation explained
PolitiFact.com | April 29th, 2010

For the purposes of this factsheet, we're focusing on the legislation put forward by Democrats in the Senate, shepherded by Sen. Christopher Dodd, D-Conn. It's 1,400 pages of new rules that change the way the financial system is regulated. The House passed its version of financial reform in December 2009 that differs on some details. But because the Senate is slow-moving and prone to requiring 60 votes for action, it seems likely the Senate bill will be a baseline for negotiations. Keep in mind this bill is a moving target. It will be amended before passage, and the Senate and House will then have to negotiate their differences before a final vote.

Here are the bill's main components:

• Consumer protection. This bureau's mission would be to help people looking for mortgages, credit cards and other financial products to avoid unfair, deceptive or abusive practices. In the Senate version, the new consumer protection bureau would be housed within the Federal Reserve, though it would have its own budget. The House version of the bill creates a standalone agency.

• Policing “systemic” threats. The bill creates a Financial Stability Oversight Council to look for overarching threats to the financial system and to recommend specific steps to rein in large financial companies when necessary. The Federal Reserve would be given new powers to regulate non-bank financial companies. A new Office of Financial Research within the Treasury Department would collect financial data and conduct research and analysis.

• “Orderly liquidation authority.” This part of the bill sets up a panel of three bankruptcy judges who convene and decide, within 24 hours, if a large financial company is insolvent. If a big firm is teetering on collapse, the Treasury Department, the Federal Deposit Insurance Corp. and the Federal Reserve would have to agree to liquidate it, using a special fund created with payments from the largest financial firms. The legislative language says the fund must be used to dissolve failing firms. To pay for the shutdowns, the FDIC would set fees on the financial companies based on their size, raising $50 billion. The fund has become a point of controversy in recent weeks. Opponents have said it means guaranteed bailouts, a claim we ruled False, and some Republicans want the fund removed from the final bill.

• The “Volcker Rule.” This rule would prohibit banks from engaging in proprietary trading, which is trading the bank's money to turn a profit. Advocates for this rule say these kinds of trades tend to put banks into a conflict of interest with their customers. The rules also would limit banks' relationships with hedge funds and private equity funds. Nonbank financial institutions also would see new restrictions.

• Derivatives. Most but not all derivatives would be traded on an exchange. A derivative is an investment usually based on some outside event. Here's an example of a good derivative: Southwest Airlines has to buy jet fuel over the coming year to run its planes. If oil prices skyrocket, Southwest loses money. So the airline invests money in something that will pay out if oil prices increase, lowering its potential for losses.
But derivatives have a dark side: During the financial crisis, derivatives exacerbated losses, especially in the housing market, and investors weren't sure who was taking the biggest losses. The new regulations are aimed at making clear who is trading in derivatives. A version of derivatives legislation sponsored by Sen. Blanche Lincoln, D-Ark., is considered particularly strict.

• Hedge funds. Generally speaking, hedge funds are investment vehicles for selected groups of elite investors. The name comes from hedge funds' tendency to be very careful about managing, or hedging, risk. This means they often buy derivatives or other unusual types of investments. Under the new regulations, large hedge funds would have to register with the Securities and Exchange Commission and report their activities. Some exemptions are provided for venture capital funds and private equity fund advisers.

• “Say on pay.” Shareholders of publicly traded companies get to vote on executive pay, though the vote is nonbinding. Translation: The company can choose to disregard the shareholders' vote. (Yes, this doesn't seem like much of a say to us. But experts tell us it's actually progress in the longstanding fight to give shareholders more of a voice in corporate governance.)

• Credit ratings agencies. The credit ratings agencies are the people who said, before the financial crisis hit, that securities built from subprime mortgages could be great investments. Wrong, wrong, wrong. The bill creates an Office of Credit Rating Agencies and puts in place rules for internal controls, independence, transparency and penalties for poor performance.

read more here: http://www.politifact.com/truth-o-meter/article/2010/apr/29/factsheet-financial-regulation-explained/

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