Financial Reform: What it all means

July 13, 2010: As Congress prepares to pass arguably the most comprehensive banking reform since the Glass-Steagall act of 1933, the question remains; what does it mean for consumers.

The Dodd-Frank Wall Street Reform and Consumer Protection Act, encompasses everything from discouraging financial institutions from excessive risk taking to regulating "interchange" fees, that banks charge merchants on debit card transactions.

With the nod from three Republican Senators, thus making a filibuster impossible, Congress looks like it is on the verge of passing legislation that has been hashed about since the 2008 collapse of several big financial institutions.

As with any legislation, the bill has both supporters and critics.

Supporters say it's the best they could do, and it's a good start. 

Critics say it goes to far, will constrain economic growth and the costs will be passed on to consumers.

Most of what is covered in the 2,400 page bill, are new federal regulations and oversight provisions. One of the biggest sticks the legislation carries is called the resolution authority which would give the government the ability to unwind a failing investment bank or insurance company in an orderly way without forcing it into bankruptcy.

In a recent New York Times interview with former Secretary of the Treasury Henry Paulson, he commended the provision and added that if he had that power back in 2008 more could have been done proactively to stop the financial system meltdown.

The other major aspects of the bill include creating a new consumer protection bureau, establishing a ten-member Financial Stability Oversight Council to oversee growing risks in the financial industry and limiting the amount of proprietary trading.

Critics argue that the bill creates to much government intervention and meddling in the free market. They claim any capping of fees or limiting of trading opportunities will just result in lower profits and higher costs to the consumer.

However it's important to look back to the original Glass-Steagall Act of 1933 to understand just how we got to this point of needed financial reform.

The Glass-Steagall Act was adopted during the great depression after a large portion of the American Banking System collapsed in 1933. The intent was to keep commercial banks and investment banks from combining standard banking products like savings accounts, mortgages and consumer loans with more risky trading.

Those rules of separation, kept a wall between traditional banking functions and emerging trading products that contributed to the 2008 financial meltdown like derivatives and credit swaps.

In 1999, President Bill Clinton signed the Graham-Leach-Bliley Act, which repealed Glass-Steagall. This allowed commercial banks, investment banks and insurers to merge.

Over ten years later, Congress is back trying to undo what they did in 1999.

This will, in the end, protect consumers but also cost them more.

Through higher fees and compliance costs, banks will have to commit a greater amount of resources which will be passed through to consumers. For Alaskans, regional banks may be impacted a lot less than nationwide banks like Bank of America.

However, higher costs and less credit might not be a bad thing for a consumer base who need to learn fiscal responsibility as well.

Over the last decade, consumers have been relying heavily on debt to fuel their spending. Many used their homes as piggy banks, stripping out all of the equity to fund their lifestyle. When housing prices dropped, many defaulted leaving a mess behind.

Due to many Americans either having bad credit or being unemployed, this has lead to a decrease in credit availability which has burdened any hopes of a broad based economic recovery.

According to FICO, 25% of consumers now have a credit score of 599 or lower which makes them a poor risk for lenders. This impacts car loans, home loans and the ability to obtain a credit card.

It's safe to say that the easy money days are over and consumers will have to get used to a new reality.

Meanwhile, the Dodd-Frank legislation won't prevent another fiscal crisis from happening -only bankers and consumers acting responsibly can do that - but it is a start.