While the financial reform bill passed and will soon be the law, it is hard to comment on any specifics because the real laws have yet to be written. Normally, when Congress passes new legislation, it is pretty specific in its intent, and Congress leaves it up to those who must enforce the laws to write rules and regulations clarifying Congressional intent.

This time, however, Congress was extremely vague in many areas, giving non-elected bureaucrats carte blanche to write rules and regulations which will become the law! Still, despite not knowing exactly what we will get, it is possible, at this time, to determine some winners and losers.

Winners and Losers

There are some big winners: lawyers and lobbyists; folks in Congress who will be consulted regarding what the rules and regulations should say; and those who want yet bigger government. There is a group that will, most likely, come out neutral: Wall Street and the "Too Big to Fail." Then there are the losers: community banks, small businesses, the taxpayer, and those who believe in free markets.

Lawyers and lobbyists will now earn megabucks trying to influence what the rules and regulations (at least 243 of them) will say and to carve out exceptions for their clients. Imagine the political donations that will now flow to Congressmen who are influential with those non-elected bureaucrats who are now crafting the language.

Wall Street, which has recently pulled back on its political contributions, can be expected to flood Washington with money in order to ensure that rules and regulations surrounding such things as the Volcker Rule (proprietary trading) and derivatives do not have a large negative impact on how they currently operate.

At this writing, while I can't say for sure they will be successful, but having observed the system for many years, I would bet heavily in favor of Wall Street. This particular piece of legislation will further concentrate the financial system and strengthen what I have referred to in other writings as the " Unholy Washington-Wall Street Alliance."

Community banking and small business are the biggest specific losers. Even prior to this legislation, community banks have been under huge regulatory stress and most now have capital constraints. But even those with the ability to lend have determined that, with loan loss reserves required against newly made loans and capital required as a cushion, it simply isn't worth it -- just buy Treasuries, which require no loss reserves or capital. And that appears to be what Washington wants, as it needs every outlet it can find for its burgeoning debt.

The financial reform bill now puts in place yet another regulatory agency, the Bureau of Consumer Financial Protection. One can be sure that the regulations emanating from this new agency will put a burden on community banks equal to that of Sarbanes-Oxley whose cost, in the middle part of the last decade, had a huge negative impact on their earnings.

As the regulatory noose tightens, small businesses, which have historically relied on community institutions and on the now defunct shadow banking system (non-bank lenders) for much of their credit needs, will continue to face a credit crunch. That's bad news for private sector job creation.

Causes of the Financial Crisis

The initial purpose of the legislation was to address the causes of the '08 financial meltdown. Does this legislation adequately address those issues? There were many contributing factors to the financial crisis, but most agree that three major ones were the subprime issues, the overleveraging of capital in the banking system with its attendant "Too Big to Fail" government policy, and the role of the Federal Reserve's easy money policies of the past 15 years. Let's look at each of these.

Fannie and Freddie

Fannie Mae ( FNM) (established 1937) and Freddie Mac ( FRE) (1970) operated profitably for most of their lives. It is widely recognized that it was Fannie's and Freddie's forays into subprime, at the insistence of the Congress that really fueled the subprime bubble. Without their purchases of subprime mortgages, the bubble could not possibly have developed.

Yet, despite the role of Fannie and Freddie, and despite a government conservatorship that is costing the taxpayers about $10 billion each month, not a single word in the 2,300+ pages of this legislation deals with these monstrosities. Think about this: with the complete control of Fannie, Freddie and the FHA (now also approaching insolvency), which are now responsible for 95% of all mortgage originations, with the government's power, influence over and alliance with Wall Street, with a new consumer agency that can and will regulate such things as the fees levels on Visa and Mastercard interchange (and, I suspect, eventually such things as ATM fees and other bank service charges), and with their tentacles now edging into the insurance business via this legislation, the whole U.S. financial system is now or will soon be under government control. Most call this socialism.

Too Big To Fail

On the "Too Big to Fail" front, instead of hard and fast rules about size (either absolute or market share) and capital, the bill establishes the Financial Stability Oversight Council which will "monitor" systemic risks and has the authority (two-thirds vote of its members) to take over and wind down any institution deemed "too risky." (Whatever happened to due process?)

The Treasury had a similar group prior to the '08 crisis, and it, along with all of the other government agencies, failed to see the growing systemic risks. What makes anybody think this group will be any better? And, given that they are composed of agency heads, it is likely that they will be politically influenced.

Furthermore, like the "bazooka" the Congress gave to Hank Paulson in '08 with the idea that since it existed it would never have to be used (until it was), this solution guarantees that it will be used in the future, and it will be taxpayer money that winds down a mega-bank that decided to take excessive risks in order to earn (and reward themselves with) excessive returns.

On the other hand, if size limits and/or capitalization requirements were appropriate, the government would never need the bazooka. If institutions never got "Too Big," then the market could absorb a failure without systemic issues, just as it does every week when the FDIC closes its given allotment of community institutions.

The Fed's Failures

The Fed, which failed so miserably at seeing the crisis, even when we were in the middle of it (Bernanke, in March '07, said that subprime had been contained) was rewarded by becoming the regulator of all large financial institutions. In effect, it can now lend money to any institution it deems could cause systemic issues.

In the 1930s, Congress added a mandate to the Fed's mission, which up until that time had only been "price stability." The 1930s mandate added the full employment objective. Despite the fact that they neither saw the crises coming nor have they been able to accomplish their employment directive, the Congress has now added a third mandate, "financial stability."

The Fed is not, strictly speaking, a government agency. It is owned, and some say controlled, by the banking system (the Wall Street banks). It resists audits and operates in secrecy. Its easy money policies of the past 15 years contributed as much as any other factor to the financial meltdown. And to this entity, the Congress has granted considerably more power!

Conclusion

The financial reform legislation solves none of the issues that caused the '08 financial meltdown. It completely ignores the Fannie Mae and Freddie Mac cancers. It institutionalizes "Too Big to Fai.l" It puts a taxpayer safety net under any mega-bank that wants to over leverage. And it rewards the Fed for its role in the bubble and its failure to even have a clue that Armageddon was upon us.

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