• U.S. Treasury to form a "Financial Stability Oversight Council" to oversee the broader financial markets and monitor systemic risks to the financial system and the economy.
• Establish an "Orderly Liquidation Facility (OLF)" that creates mechanisms for liquidating systemically important firms under the FDIC. Banks would have to pay fees to build a $50-billion fund over 10 years.
• CFTC authority broadened to require certain "standardized" derivatives transactions to take place on registered exchanges with enhanced reporting requirements.
• The role of the SEC will be substantially expanded, with additional registration and systemic risk reporting requirements for derivatives traders, large hedge funds, and expanded supervision of the credit rating agencies.
• Originators of mortgage-backed securities and other CDOs to hold at least 5% of the credit risk.
• Establish an "Office of National Insurance" under the Treasury to monitor industry, identify national insurance issues, and establish standards and report on insurance industry systemic risk issues.
• "Bureau of Consumer Financial Protection" would be created under the Federal Reserve.

Major Problems of the Various Proposals:

• Congressional audits of monetary policy decisions of the Federal Reserve's FOMC—this risks increasing political interference in the monetary policy decision-making process.
• Federal Reserve's supervisory authority over banks would be scaled back to focus only on banks with assets over an arbitrary limit of $50 billion (approximately 20 banks)—the information that the Fed gleans from the supervision and examination of banks is critical for making effective monetary policy decisions, especially when credit growth in the economy is constrained by limited banking system core capital.
• Prohibiting banks from engaging in proprietary trading of swaps and derivatives—this activity would be pushed out into less regulated markets and traders, and thus potentially fall below the radar of the new mechanisms for systemic risk monitoring. The chairman of the FDIC, Sheila Bair, has already voiced strong opposition to this proposal.
• Substantially increasing the burden of fees that banks pay to the Fed for supervisory activities, into the FDIC for deposit insurance and to fund the OLF. The "feeding frenzy of fees" could put U.S. banks at a severe competitive disadvantage versus other international banks and will potentially move financial activity to lower-cost foreign bank platforms and into offshore locations.

Outlook

The Senate reform proposals address key issues such as revamping and streamlining the structure of the financial and regulatory system, the role of the Federal Reserve, systemic risk mitigation, "too big to fail" institutions, and stabilizing the massive financial derivatives market. There are many strong merits to the legislation, but also some major problems.

Once the Senate bill passes, it will move into conference committee to be reconciled with the already-passed House bill.

If Congress can find a way to take the major negatives off the table, then the process has the potential to deliver an effective and powerful set of new financial regulations, mechanisms, and institutions without creating unintended consequences of stifling financial innovation and rendering the U.S. financial system uncompetitive in world financial markets.