The Dodd-Frank Wall Street Reform and Consumer Protection Act does not address the enormous commercial real estate exposures burdening the balance sheets of many U.S. banks and stalling new lending activity. Perhaps most important, it does not repair the shattered housing finance system—an essential mechanism for a robust economic recovery.
In July, the landmark Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law by President Obama. While this brought to a close a frantic, yearlong legislative effort to overhaul the U.S. financial system, the action on financial reform now switches to the U.S. Treasury Department and numerous federal regulatory agencies as hundreds of implementing regulations are written and put out for comment. For example, regulators still need to decide which companies should be designated “systemically significant” and face higher capital standards and greater supervision. While the initial rulemaking process is expected to take six to 18 months and involve at least 11 federal agencies, some of the bill’s provisions are not expected to take effect for several years.
Because of the amount of work still to be completed by regulators, critics of the new law complain that the measure perpetuates uncertainty. “It creates vast new bureaucracies with little accountability and seriously undermines the competitiveness of the American economy,” says Senator Richard Shelby (R-AL), the ranking Republican on the Senate Banking Committee, who opposed the legislation.
While Senator Ted Kaufman (D-DE) supported the Dodd-Frank reform legislation, he expressed his reservations to reporters, saying, “Congress largely has decided . . . to punt decisions to the regulators, saddling them with a mountain of rulemakings and studies.” Even Senate Banking Committee Chairman Chris Dodd (D-CT) expressed bewilderment, telling reporters after the final vote, “No one will know until this is actually in place how it works.”
As many wade through analysis of the highly complex 2,300-page bill, top lawmakers have already acknowledged that a corrections bill may need to be enacted to clean up the legislation. Due to the haste of work on the bill and the lack of critical detail in many complicated provisions decided in the early-morning hours of a marathon 20-hour conference session, additional legislation likely will be necessary to fix problems with it.
But how far the corrections bill could go remains a question. Some say it may be confined to technical changes to better reflect congressional intent; others see an opportunity to make more substantive alterations.
For real estate, the law does not address the enormous commercial real estate exposures burdening the balance sheets of many of the nation’s banks and stalling new lending activity. It does not repair the asset-backed securitization markets, nor does it create the framework for a U.S.-covered bond market. It will not enhance credit capacity, encourage capital formation, or aid economic expansion. Perhaps most important, it does not repair the shattered U.S. housing finance system—a mechanism essential for a robust economic recovery.
In fact, the U.S. Treasury Department indicated in July that it will not propose an overhaul of U.S. housing finance until next year as it concentrates first on implementing landmark financial reforms. Early next year, some three years into the crisis, Treasury will issue a paper outlining proposals and recommendations for reforms of Fannie Mae and Freddie Mac.
Nonetheless, the Real Estate Roundtable, a nonprofit public policy organization based in Washington, D.C., along with its industry partners lobbied to help shape a number of compromises within the legislation on critical issues affecting real estate.
The following is a quick summary of key provisions of the new law that could affect real estate.
- OTC derivatives. Derivatives that trade in over-the-counter (OTC), bilateral deals will be forced through central clearinghouses—to curb the risk from one counter-party going bankrupt—and onto electronic exchanges to increase transparency. Exemptions exist for nonfinancial companies—end users—using the contracts to hedge risk. Banks will be forced to spin off some of their derivatives-dealing operations. The Real Estate Roundtable and its partners in the Coalition for Derivatives End-Users have been working with lawmakers to protect a company’s ability to manage its individual risk exposures by ensuring access to reasonably priced and customized OTC derivatives products. The swap dealer language in the final bill language demonstrates a clear intent that end users not be designated as swap dealers—and subject to bank like regulation—because entities within the corporate structure execute swaps through an affiliate.
- Securitization. Banks that package loans are required to keep 5 percent of the credit risk on their balance sheets. However, the new law directs bank regulators to exempt from the new rules a class of low-risk mortgages that meet certain minimum underwriting standards. Regulators can permit alternative risk-retention arrangements for the commercial mortgage–backed securities (CMBS) market. Under the provision, a third-party investor—in addition to the securitizer or originator of loans—is permitted to satisfy requirements for CMBS as long as that investor performs due diligence, purchases a first-loss position, and retains this risk in accordance with the statute.
- FAS 166 and 167. Before any rulemaking, financial regulators are required to examine and report on the combined impact of new accounting standards—Financial Accounting Standard (FAS) 166 and 167—and other regulatory changes, such as a “retention” mandate, on credit availability. Under the provision, the Federal Reserve, working with other agencies, has 90 days to report its findings to Congress with recommendations on statutory and regulatory changes that could be made to reduce the impact on credit availability.
- Credit-rating agencies. The law will revamp the credit-rating industry, establishing a new quasi-governmental entity designed to address conflicts of interest inherent in the credit-rating business after the Securities and Exchange Commission (SEC) studies the matter. It also allows investors to sue credit-rating firms for a “knowing or reckless” failure to conduct a reasonable investigation—a lower liability standard than the firms were lobbying to get. It also establishes a new oversight office within the SEC.
- SEC registration requirements. Effective one year from the date of enactment of the law, hedge funds that manage over $100 million will be required to register with the SEC as investment advisers and to disclose financial data needed to identify systemic risks. The assets threshold for federal regulation of investment advisers will be raised from $25 million to $100 million. Investment advisers to private equity firms with more than $150 million in assets under management will also be required to register with the SEC. l
- Systemic risk regulation. A Financial Stability Oversight Council of regulators chaired by the treasury secretary is to identify systemically significant companies and monitor markets for bubbles. Companies branded as systemically significant will face stricter capital, leverage, and liquidity standards and be obliged to draw up a “living will” to describe how they would be broken up in the event of failure. l
- Volcker rule. Federally insured deposit-taking banks are banned from proprietary trading and from owning more than a small slice of hedge funds and private equity firms. Included at the urging of former Federal Reserve chairman Paul Volcker, this provision is intended to prevent banks from engaging in “casino” activities while benefiting from government insurance of their deposits. Regulators must still come up with an adequate operational definition of the trading practices in question and will have wide latitude to determine how it is implemented and which investment activities are exempted.
- Financial Stability Oversight Council. This new council will be composed of the heads of nine federal regulatory agencies and an independent insurance member, plus five nonvoting members. The council chair will be the treasury secretary, who will be charged with identifying and responding to emerging risks throughout the financial system, including the designation of systemically significant firms. The council’s first quarterly meeting will be this October.
- Resolution authority. The new law empowers the federal government to seize and wind up a large institution if it faces impending failure and poses a risk to the broader financial system. Payments to creditors will be paid by the government but recouped later from levies on the industry. This provision is designed to prevent a repetition of the market shock from Lehman Brothers’ bankruptcy and end implicit government guarantees that reduce funding costs for banks deemed “too big to fail.”
- Consumer protection. A new Consumer Financial Protection Bureau (CFPB) will be established within the Federal Reserve, but with complete independence from the central bank; it will tackle abusive selling of mortgages, credit cards, and other loan products. Banks and other finance providers worry about onerous and redundant reporting standards, the possibility of credit products being banned, and the dearth of checks on the power of the CFPB chairman.
The new law empowers the federal government to seize and wind up a large institution if it faces impending failure and poses a risk to the broader financial system. Payments to creditors will be paid by the government but recouped later from levies on the industry.
As federal regulatory agencies study how to implement the new law, what happens next largely will depend on decisions made by regulators at places like the Federal Reserve, the Federal Deposit Insurance Corporation, the Treasury Department, the SEC, and the Commodity Futures Trading Commission (CFTC), which helps explain why the colossal new law’s long-term impact is so uncertain.
The Real Estate Roundtable, as well as its industry partners, will remain engaged in the debate as the multiagency regulatory implementation phase begins.
