Post Election Alert: Financial Services
November 2008
Authors:
Daniel F. C. Crowley
+1.202.778.9447
dan.crowley@klgates.com
Karishma Shah Page
+1.202.778.9128
karishma.page@klgates.com
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Financial Services Reform: What Comes Next?
The historic November 4th election resulted in unified Democratic Party control of the Administration
and Congress. This new political dynamic will significantly impact current and future policy
initiatives relating to the financial services industry.
This alert describes the policy measures recently put in place to address the credit crisis, the impact of
the election, and the likely issues to top the financial services reform agenda in the 111th Congress.
Recent Policy Initiatives
In the past months, a number of policies have been oriented towards restoring liquidity in the credit
markets. Foremost among these measures has been the Emergency Economic Stabilization Act of
2008 (EESA), which authorizes up to $700 billion for the Department of Treasury to purchase (under
the Troubled Asset Relief Program) and insure (under the Troubled Assets Insurance Financing
Fund) illiquid financial instruments. The Treasury has used this authority to create the Capital
Purchase Program, which will provide $250 billion in equity capital directly to certain U.S. financial
institutions through the purchase of senior preferred stock.
Consensus has been building, however, that additional, comprehensive reforms are needed to address
the recent unprecedented events in the financial markets. As a result, policy makers have made reform
a priority, setting the stage for the most significant reshaping of the legal and regulatory landscape
for the financial services industry since the Great Depression.
Impact of the Election
President-Elect Obama
In the near term, President-elect Obama will turn his attention to selecting his economic leadership
team. A key appointment will be the Secretary of the Treasury. Possible choices include former
Treasury Secretaries Larry Summers and Robert Rubin, FDIC Chairwoman Sheila Bair, New York
Federal Reserve President Timothy Geithner, and former Federal Reserve Chairman Paul Volcker.
President-elect Obama also has called for the passage of an economic stimulus package during the
lame-duck Congressional session – and has said that if it doesn’t happen then he will make it one
of the first orders of business when he is sworn in.
Additionally, President-elect Obama has stated that the “United States can take a leadership role
in coordinating a global response to the present [financial] crisis, as well as greater regulatory
cooperation and alignment to prevent future crises.” In the near future, President-elect Obama’s
support for a globally coordinated response to current financial challenges will impact the G-20
summit on international financial market regulation to take place on November 15 in Washington,
DC. Although the White House has stated it does not expect the President-elect to formally participate
in the G-20 summit, some G-20 delegates have indicated their desire to engage with him while in
Washington, DC.
The 111th Congress
As a result of the election, Democrats will strengthen their majorities in both the House and Senate
when the 111th Congress is seated in January. In the Senate, the party gained 6 seats, increasing their
majority from 49 Democrats, 49 Republicans, and 2 Independents to 55 Democrats, 40 Republicans,
and 2 Independents. In the House, the Democrats increased their seats by 16, increasing their majority
from 239 Democrats and 199 Republicans to 255 Democrats and 174 Republicans. At the time of
this writing, three Senate seats and six House seats were yet undecided.
Post Election Alert: Financial Services
The unity of party control between the new Administration
and the 111th Congress is likely to foster a working relationship
between the two bodies and lead to a common prioritization
of the financial services reform agenda. Among the issues
likely to garner immediate attention include oversight of
EESA implementation, bankruptcy reform, mortgage reform,
and reform of the capital markets regulatory structure.
Whereas the Republican minority was able to block
legislation perceived as adverse in the 110th Congress, the
larger Democratic majority in the 111th Congress will not
face as difficult an obstacle. Influential Democratic members
will have stronger committee and floor support to move
legislation. The gain in the Senate is particularly significant
because it brings the party close to the 60-vote supermajority
required for cloture, a procedure to prevent a filibuster.
In fact, in the week before the election, Senate Majority
Leader Harry Reid asked Senate offices to resubmit bills that
failed to achieve cloture in the 110th Congress. Considering
the complex nature and broad impact of financial services
issues, however, it is likely that many reforms will require
the support of a diverse bipartisan coalition.
Key Committees
There are multiple Congressional committees with
jurisdiction over matters relating to the financial services
industry, most notably the House Financial Services and
Ways and Means Committees, and the Senate Banking,
Housing, and Urban Affairs and Finance Committees.
Final committee assignments will not be announced until
the beginning of the year, but a few aspects of committee
leadership and membership can be anticipated.
Senate Banking Committee Chairman Christopher Dodd (DCT) recently stated that he intends to remain in his current
position given the significance of the pending financial
services reform issues. Regarding the House Financial
Services Committee, Chairman Barney Frank (D-MA) is
expected to assert considerable influence over the pending
regulatory reforms. House Capital Markets, Insurance,
and Government-Sponsored Enterprises Subcommittee
Chairman Paul Kanjorski (D-PA) prevailed in a difficult
election and will therefore remain an important player on
financial services issues. Congressman Jeb Hensarling (RTX), an influential Republican member of the committee
and Chairman of the Republican Study Committee, is likely
to seek the House Republican Conference Chairmanship.
A staunch critic of government spending and the bailout
package, Congressman Hensarling can be expected to play
an important role on financial services reform issues for the
Minority. Another influential Congressman, Kevin McCarthy
(R-CA), is also frequently discussed as a possible member
of the GOP leadership, perhaps as Chairman of the National
Republican Congressional Committee. Finally, House Ways
and Means Committee Ranking Minority Member Jim
McCrery (R-LA) has retired, creating competition for that
important position.
The increase in the Democratic majority will translate into
an increase in the ratio of Democrats to Republicans on each
committee. Additionally, although membership on the key
committees will likely remain largely unchanged, there will
also be some noteworthy changes. Three former Republican
members will no longer be serving on the Senate Banking
Committee. Senators Chuck Hagel (R-NE) and Wayne Allard
(R-CO) both retired, and Senator Elizabeth Dole (R-NC) was
defeated. Senate Finance Committee member Senator John
Sununu (R-NH) also lost his bid for reelection.
A number of members of the House Financial Services
Committee were defeated. On the Republican side,
Congressmen Tom Feeney (R-FL) and Chris Shays (R-CT)
were defeated, and Congresswoman Deborah Pryce (R-OH)
and Congressman Steve Pearce (R-NM) retired. On the
Democratic side, Congressmen Tim Mahoney (D-FL) and
Don Cazayoux (D-LA) also lost their seats. On the House
Ways and Means Committee, eight of seventeen Republican
members and two of the Democratic members will not be
returning for the 111th Congress.
The Legislative Agenda
Lame-Duck Session
In the next few days, House and Senate Democratic leaders
will determine the agenda for the lame-duck session.
Immediately following the election, President-elect Obama,
House Speaker Nancy Pelosi (D-CA), and Senate Majority
Leader Harry Reid (D-NV) indicated their interest in passing
a second economic stimulus measure in the near term. The
new stimulus package is estimated to cost between $100
billion and $300 billion. Details of the stimulus package
will be negotiated in the coming weeks. There are, however,
a number of proposals that have been offered. House
Speaker Pelosi and members of the House Transportation
and Infrastructure Committee have called for the inclusion
of infrastructure projects in the stimulus measure as a
mechanism for job creation and economic growth. Green
technology projects, such as alternative energy development
and broadband network expansion, are likely to be the focus
of such infrastructure funding. Certain Republican members
have called for the economic stimulus plan to include tax
relief. Proposals range from lowering tax rates, lowering or
suspending capital gains taxes, and expanding certain tax
credits. Other programs that may be considered for inclusion
in the new stimulus package include homeowners assistance,
unemployment insurance, Medicaid, food stamps, and lowincome heating assistance.
November 2008 | 2
Post Election Alert: Financial Services
Moving Forward
Mortgage Industry
As noted previously, with the election now behind them, the
new Administration and Congress will turn their attention
to a comprehensive and systematic reform of the legal and
regulatory systems that impact the financial services industry.
It is anticipated that all parts of the financial services industry
will be impacted and some of the reforms will be quite
comprehensive. Short descriptions of some of the areas on
which we expect the new Administration and Congress to
focus follow.
The new Administration and Congress are likely to continue
reform of the mortgage industry. During the campaign,
President-elect Obama called for standardization of
mortgage-lending regulations that apply to mortgage brokers,
commercial banks, and thrift organizations. Clearly, the
future of the GSEs will also be at issue.
Capital Markets Regulation
The most overarching reform likely to be considered by the
new Administration and 111th Congress is an overhaul of
the financial services regulatory system. The current system
of oversight agencies has evolved over many years and is
characterized by multiple agencies with overlapping and
conflicting responsibilities. Reform discussions may begin
with the Treasury’s March 2008 “Blueprint for a Modernized
Financial Regulatory Structure.” The Blueprint suggests
that the Federal Reserve Board be repositioned as a market
stability regulator. In this larger oversight role, the Federal
Reserve would have the ability to monitor risks across the
financial system and take corrective action. The Blueprint
also calls for a new entity, created through the merger of the
Commodity Futures Trading Commission and the Securities
and Exchange Commission, to act as a business conduct
regulator. In addition to multiple, ongoing Congressional
hearings on these issues, EESA created a Congressional
Oversight Panel that is to make recommendations to Congress
by Inauguration Day, January 20, 2009. In any case, it seems
likely that the creation of a market stability regulator with
broad oversight functions and reconsideration of CFTC and
SEC oversight responsibilities are likely to be key aspects
of the reform discussion.
Hedge Funds, Private Equity Funds, Sovereign Wealth
Funds
A key priority of the new Congress is likely to be the
regulation of a broad array of previously unregulated or
weakly-regulated capital markets participants. There is much
discussion of “dark pools” of capital that have the potential
to create systemic risk and yet are currently unregulated or
less regulated. Such entities include hedge funds, private
equity funds, sovereign wealth funds, and other alternative
investments. New governing regimes will likely focus
on increased transparency by these market participants
through registration, public disclosure, and other regulatory
requirements.
Credit Rating Agencies
Credit rating agencies are another likely target for reforms in
the next Congress. Earlier this year, the SEC conducted an
investigation of credit rating agencies and found significant
weaknesses that contributed to the financial crisis. Policy
efforts are likely to center on more rigorous regulatory
standards in these areas. A Congressional priority is likely
going to be modification of the current “issuer-pays” system
as a way of mitigating conflicts of interest. Congress may
also consider legislation to standardize, document, and
disclose the criteria, policies, and practices used by credit
rating agencies in determining credit ratings.
Defined Contribution Plans
Citing the current market volatility, House Education and
Labor Committee Chairman George Miller (D-CA) and
other Members of Congress have indicated a strong desire to
reform the participant-directed retirement system in the next
Congress. Preconceptions about the riskiness of subjecting
retirement savings to market volatility have been exacerbated
by the current bear market. In a traditional defined benefit
pension system, plan participants were insulated from market
machinations and the sponsoring employers bore the risk of
loss. Congress is likely to consider ways to impose defined
benefit concepts on the defined contribution system which
will impact 401(k), 403(b), 457 and other plans. These
proposals will likely focus on plan investment options,
fees, and revenue-sharing arrangements. We also expect
Congress to reconsider defined contribution plan regulations
issued by the Department of Labor under the outgoing Bush
Administration.
CDS and Other Derivatives Trading
Given the prominent role that some derivatives products,
including credit default swaps (CDS), have played in the
credit crisis, policy makers have been calling for increased
standardization and transparency of these products and are
currently considering the need to establish a centralized
clearinghouse for derivatives transactions. Most recently,
the Federal Reserve has been organizing industry efforts to
establish a derivatives clearinghouse. As these developments
progress, the new Administration and Congress are likely
to conduct oversight hearings and may call for additional
measures including new regulatory regimes.
November 2008 | 3
Post Election Alert: Financial Services
Optional Federal Charter for Insurance Companies
Insurance companies have traditionally been regulated at the
state level. Many insurers, forced to comply with fifty-one
regulatory systems, argue that reform is required because
the current system is overly complex, is costly, and stifles
innovation. One option for reform, the Optional Federal
Charter (OFC) for insurance companies, was considered by
the 110th Congress, and is likely to be reintroduced in the
111th Congress. The concept was also proposed in Treasury’s
March 2008 “Blueprint for a Modernized Financial
Regulatory Structure.”
The OFC would create an optional, entirely new federal
regulatory system for insurance companies. Similar to the
banking industry’s dual regulatory system, the dual chartering
system would allow insurers to organize themselves under
either federal or state law. Federally chartered insurers
would be supervised by a new federal bureau and governed
primarily by federal law. In addition, the companies would
not be subject to state regulation of pricing.
Federal Tax Issues
With the 2001 and 2003 tax cuts set to expire in 2010, the
new Administration and the 111th Congress will have to
consider certain aspects of the federal tax system. One issue
receiving considerable attention is the appropriate tax rate
on capital gains and dividends. Prior to 2003, capital gains
were taxed at 20% and dividends were taxed as ordinary
income. In 2003, the tax rate for both capital gains and
dividends was reduced to 15%. These rates, however, are set
to expire in 2010, reverting to pre-2003 levels. It is unlikely
that a Democratic Congress will make the 2001 and 2003
tax rates on capital gains and dividends permanent. During
the campaign, President-elect Obama proposed that the top
capital gains rate and the top dividends rate be set at 20%.
With the cost of the bailout predicted to ultimately cost as
much as $1 trillion, and other costly new programs on the
agenda, the new Administration and Congress will be forced
to consider revenue-raising proposals in order to satisfy
“Pay-As-You-Go” rules. Several proposals that impact the
financial services industry are likely to be seriously discussed,
including changing the tax treatment of certain financial
products, amending rules that impact the carried interest
of private equity and hedge funds, and further limiting the
deductibility of executive pay and compensation.
Credit Card Companies
Congress is also expected to continue its scrutiny of credit
card issuers in the upcoming session. Reforms will likely
focus on issuer policies as they relate to consumers. Areas
ripe for consideration include restricting “any time, any
reason” increases in interest rates and terms, limiting penalty
rates and fees, and requiring enhanced disclosure.
Congress may also target interchange rates charged by
credit card issuers to merchants. Merchants argue that Visa
and MasterCard, which account for 80% of the credit card
industry, use their market share to increase interchange fees.
Reform efforts pursued in the 110th Congress, allowing
merchants to collectively negotiate with banks on fees and
terms, are likely to be reinitiated in the coming months.
Conclusion
It is clear that the new Administration and Congress will enact
the most significant financial services reforms in generations.
It is also clear that there will be winners and losers in this
process, and all segments of the financial services industry
should expect to be impacted in some way. However, as of
now the legislative outcome is uncertain. It is subject to input
from many different interest groups, including investors,
consumer advocates, labor unions, trade associations, think
tanks, and financial services providers. Therefore, a key
decision management must make is whether to affirmatively
impact this policy making process. Market participants who
are not adequately represented will likely have their new
competitive environment determined largely by others who
are actively engaged.
The K&L Gates Public Policy and Law group consists
of senior, bipartisan policy professionals who are closely
monitoring these developments in order to provide insights
to and effective advocacy on behalf of firm clients.
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