The Dodd-Frank Act is a sweeping legislation designed to create and maintain a stable financial system. It creates new federal oversight organizations and rules for most financial companies and the products they sell. Here's what the new Act means for you. IN PICTURES: Eight Ways To Survive A Market Downturn
The Act creates a new Consumer Financial Protection Bureau (CFPB) under the Federal Reserve (Fed). The CFPB is responsible for consumer financial education, creating financial curriculum and making it available to the public. It will have the power to create and enforce new rules for just about every type of financial transaction in which consumers engage, including: home loans, credit cards, bank accounts, car loans, payday loans and others. The new rules carefully monitor how these products and services operate, and how they are sold. The CFPB's power is daunting, and has nervous financial institutions scrambling.
The Impact: The Act protects the public from scams and insures quality financial services are available, and fairly priced, in all communities. It even stipulates diverse staffing of financial institutions. Financial organizations from credit unions and mortgage companies to debt collectors will be under constant oversight by the CFPB providing consumers with peace of mind.
Americans will have more reliable information about their finances in easy-to-understand English (maybe Spanish, too?). Topics like credit scores, risk, fees and penalties will be more clearly defined, giving purchasers more control over their money. Informed consumers are less likely to become fraud victims. If something goes awry, you will have one point of contact for help.
Consumers may find changes to the way their existing accounts work. For example, your bank may stop automatically charging overdraft fees, and instead decline overdrawn charges. It may be more difficult to qualify for a loan, but you will be more likely to afford it. Financial organizations will have to be more creative to make a profit, so you may find new services (offered for a fee of course).
What You Should Do: Pay attention to the details of financial transactions; ask questions and comparison shop. You can no longer assume that the accounts you currently have will work the same or cost the same. If you haven't received letters from your financial institutions - you will. Make sure you understand the changes.
Insurance, Derivatives and Securitized Investments
Complex financial products will be more uniformly regulated for risk, and safety and financial organizations will be held responsible for them. The federal government will review insurance product safety. It will encourage availability of insurance in underserved communities. Derivatives will be treated more like other securities requiring full disclosure of risks and centralized exchange trading. The creators of securitized investments such as mortgage-backed securities will be required to maintain an equity stake.
The Impact: Investors can expect the same level of regulations for sophisticated investments that is given to other investments. The amount of risk and the costs will be known to investors. Investors will have new methods of evaluating and comparing complex investments, and advisors will be required to act in the best interest of their clients.
What You Should Do: Learn as much as you can before investing or borrowing money. Select investments based on your personal risk tolerance. Given all the information, if you still don't understand an investment, don't buy it. (To learn more, see The Barnyard Basics Of Derivatives.)
New Economic Indicators
Experts are charged with evaluating measurements designed to prevent future financial upheaval. Capital requirements will prevent organizations from teetering on the brink of failure. The size and complexity of financial institutions will be restricted. Traditional merger and acquisition industry growth strategy will be tempered with required exit strategies and no assurance of a government bailout.
The Impact: Financial institutions will be required to maintain higher amounts of assets in reserve, so the total amount of money available for loan will be lower, but the organizations will be financially more secure. Large institutions will not have a monopoly on brokerage, banking and mortgage services, and we will have notification and remedies for potential problems. Basically, your tax dollars will not be used to save wayward financial institutions.
What You Should Do: Traditional fundamental notions about the status of the economy need to be taken into account, along with the new measurement system. Our investments, interest rates and other traditional notions need to be weighed against the new evaluation criteria.
Executive Compensation Guidelines
Bonuses have been a staple of financial management compensation. Shareholders will now have a say in the amount of executive bonuses. The theory is, by eliminating short-term (often quarterly) rewards, the executives will be forced to act based on long-term objectives. The opposition contends the best, and the best and brightest managers avoid the industry in favor of more lucrative careers. (For more, check out Evaluating Executive Compensation.)
The Impact: It is possible that shareholders will see higher values for their investments if cash otherwise paid out in bonuses were reinvested or paid out as dividends. Shareholders themselves are guilty of pursuing short-term gains. Decisions made to reap quick fortunes may not be worth it, as executives take fewer risky moves - which may result in lower earnings.
What You Should Do: Understand the changing pay structure of financial institutions. Evaluate each company based on its commitment to the well-being of its employees, shareholders and the overall objectives of the organization.
The Bottom Line
Some people are more hands-on with their finances. Others prefer to consult an expert. Whichever type of financial consumer you are, remember that much of this legislation was designed to prevent bad things from happening by transferring information to consumers and holding financial institutions accountable for their products. Responsibility is in the hands of both. (For more, check out Governance Pays.)