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From Wall Street to Main Street: The impact of financial reform on consumers and investors By Abigail Huffman Director, research, Investment Division July 2010 The Dodd-Frank Wall Street Reform and Consumer Protection Act¹ might be the most significant piece of legislation to impact financial services since the Glass-Steagall Banking Act of 1933. The new rules attempt to curtail risky business practices to avoid potential financial crises and protect the consumer. Impact and consequences Beyond the changes proposed to the financial system at large, the legislation also introduces changes affecting many American consumers and investors. While I won't attempt to encapsulate all the elements of the bill, there are a few immediate highlights that stand out in terms of impact and possible unintended consequences. One of the highlights of the Act is that the "too big to fail" bailouts will effectively be history. Regulators can authorize firm closures if they are judged as overly risky and taxpayers are not obligated to "save" a financial institution. Under the Act, a Financial Stability Oversight Council comprised of ten regulators (from the Federal Reserve, Treasury and the SEC) will work to identify system-wide problems before they become catastrophic. A new Federal Insurance Office will also provide industry oversight historically limited to the states. The legislation introduces new costs to banks, dictating greater reserves and less debt on the banks' books. Banks have reacted by hoarding cash and lending less. Prior to the Lehman and Bear Stearns failures, banks could lend up to thirty times their amount of capital — that ratio is now below ten. Transactions of derivatives, or financial instruments that derive value from other financial instruments, will also be moved away from inter-bank agreements to an independent exchange. Derivatives trading related to the volatile agricultural and energy commodities and other complex securities must be transferred from the bank to a holding company. The Act's Volcker Rule is also designed to limit banks' ability to make speculative investments for their own profit rather than on behalf of their customers. The Volcker Rule will define the extent that firms can trade their own funds (e.g., proprietary trading which can lead to conflicts of interest). Intended benefits Several intended benefits to consumers will also be introduced, including the newly created Consumer Financial Protection Bureau which will ensure that Americans receive clear and accurate information about mortgages and credit cards. In addition, consumers can pursue education through the new Office of Financial Literacy. The Federal Reserve is also committed to setting reasonable debit card fees within nine months after the bill is passed. In addressing mortgage reform, lenders will be penalized for irresponsible lending and prohibited from charging pre-payment penalties. Banks face the loss of lucrative fees related to riskier products such as subprime mortgages, and borrowers will be able to receive housing counseling through the Department of Housing and Urban Development (HUD). Unintended consequences In attempting to introduce greater stability and clarity to the financial system, the Dodd-Frank legislation increases the costs of doing business for financial institutions. While providing a variety of arguable benefits, some might assume that higher costs will be passed on to clients and customers and potentially produce some unintended consequences: Bank investors could make less - Banks stand to become less profitable due to higher reserve requirements and risky activities restrictions ("financial innovation"), which could impact some investors' returns. Consumers may have less access to credit and mortgages - Numerous safeguards are designed to protect consumers from predatory practices. However, some consumers may now have no access to funds due to higher down payment mandates and other strict criteria. Hedgers could pass on higher fees - Farmers, airlines and industries often use derivatives contracts to lower risk by locking in advance prices for commodities such as corn, beef, fuel and metals². An increase in transaction costs or making it harder to create these hedges would likely drive up prices. Regulation could become stagnant - Regulators could become less proactive or future legislation may be impeded if consensus regards the Dodd-Frank Act as the final answer to fixing financial institutions. While the ramifications of the Dodd-Frank Act are still yet to be seen, many consumers and investors will feel the impact of greater transparency in financial services and increased consumer protection. 1 See http://thomas.loc.gov/cgi-bin/query/z?c111:H.R.4173: for full text of the Dodd-Frank Act and http://financialservices.house.gov for bill summary and highlights 2 See "Finance Overhaul casts long shadow on the plains," Wall Street Journal article, July 14, 2010 These views are subject to change at any time based upon market or other conditions and are current as of the date at the top of the page. The opinions expressed in this material are not necessarily those held by Russell Investments, its affiliates or subsidiaries. While all material is deemed to be reliable, accuracy and completeness cannot be guaranteed. The information, analysis, and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual or entity. The information, analysis, and opinions expressed herein are for general information only. Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional. Russell Investment Group is a Washington, USA corporation, which operates through subsidiaries worldwide, including Russell Investments, and is a subsidiary of The Northwestern Mutual Life Insurance Company. The Russell logo is a trademark and service mark of Russell Investments. Russell Financial Services, Inc., member FINRA, part of Russell Investments. For information on the Financial Industry Regulatory Authority, go to www.finra.org. Copyright © Russell Investments 2012. All rights reserved. First used: August 2010. RFS 10-3727			How to invest with Russell   Weekly market updates Watch Market Week in Review   Also available Subscribe to our market insights RSS Learn more about RSS Printer friendly version of this page

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