A Fresh Chance for Congress to Do Right by the CFTC

As the appropriations process moves forward this month and next, lawmakers again have a chance to properly fund the Commodity Futures Trading Commission. This is an agency whose responsibilities have far outstripped its resources, as detailed in an AFR fact sheet and charts of the agency’s workload versus budget and workload versus workforce.

The CFTC plays a crucial role in financial regulation. In the first place, it oversees the commodity derivatives markets, which help determine the price of everyday items ranging from gasoline to bread. The Dodd-Frank Act also gave the CFTC responsibility for the vast and previously unregulated financial derivatives markets, which helped crash the world economy in 2008. With its expanded mandate, the CFTC has seen an eight-fold increase in the size of the markets it is charged with overseeing. Yet the Commission has yet to receive anything close to the funding proposed by the administration or sufficient to do its job. — Marcus Stanley

 

When Salespeople Call Themselves Advisors

Saving for retirement is extra-hard these days, and not just because wages are low and millions of Americans are still struggling to make up for ground lost after the 2008 financial crisis. All too often, the difficulty is compounded by gaps in the rules for the financial professionals who provide retirement-planning advice.

As things now stand, too many of those professionals can present themselves as (and enjoy the benefits of being perceived as) advisors with your best interests in mind, yet go ahead and recommend investments that will generate more money for themand less for you.

It’s a huge problem, and the Securities and Exchange Commission and the Department of Labor are each in a position to fix important pieces of it. The SEC’s part goes back to a 1940 law which gave registered investment advisors a fiduciary duty to look out for the best interests of those they serve, while treating broker-dealers as salespeople with only a looser obligation to recommend “suitable” investments. The Labor Department entered the picture in 1974, when the Employee Retirement Income Security Act authorized it to regulate employer-sponsored retirement plans and some of the professionals who help people make decisions related to those plans.

But the rules overseen by both agencies are outdated. Over the past several decades, retail investment products have become far more complicated, and with 401(k)’s and Individual Retirement Accounts replacing the defined-benefit pensions of old, responsibility has shifted from employers onto the shoulders of workers and retirees. This combination of trends has greatly increased the power of financial advisors to influence people’s fortunes for good or ill.

Nowadays, brokers frequently act as advisors, providing “investment planning” or “retirement planning” expertise; yet the SEC continues to define and regulate them as salespeople. The Labor Department sets a stricter standard for some forms of advice, but its rules, which have not been updated in 40 years, are narrow, excluding many of the situations that matter most, such as advice given to employees about what to do with their 401(k) money when they retire or change jobs. Far too often, the record shows, financial professionals take advantage of the wiggle room between perception and regulation to promote high-commission investment products over alternatives with lower fees, better returns or fewer risks.

The Dodd-Frank Act of 2010 empowered the SEC to establish a fiduciary standard for all professionals who give investment advice. But the commission has moved slowly, and has yet to indicate when it will act, if it does. The Department of Labor, by contrast, has made the issue a priority, and now appears to be on the brink of using its authority to issue tougher rules for a broader range of circumstances than its current regulations cover.

That prospect, however, has stirred fierce resistance from broker-dealers and other elements of the financial industry seeking to preserve a highly profitable status quo. They are working hard to convince anyone who will listen, including elected officials, that a fiduciary standard would prevent them from being fairly compensated for giving advice. That, they argue, would make it impractical for them to share their expertise with any but high-income clients, leaving middle-income workers and retirees to negotiate these dangerous waters without any guidance.

But the premise is false. The rulemakers have made it clear that a fiduciary standard need not and would not keep brokers from being properly compensated. Moreover, we have a record of experience to show us that it does not have that effect. California, Missouri, South Dakota and South Carolina have already imposed a broad fiduciary-duty standard; in all four states, brokers continue to be paid for their services, and they continue to offer them to clients up and down the income ladder.

What’s at stake, then, is not whether some clients will be able to get advice, but whether some financial professionals will be allowed to profit by giving bad, self-serving advice. And there is abundant evidence of misrepresentation and obfuscation under the current rules.

A 2013 report by the Government Accountability Office cited many examples of financial advisors aggressively encouraging people to roll their 401(k) funds over into IRAs, often with only minimal knowledge of a client’s financial situation. Call-center representatives, the report showed, frequently claimed that 401(k) plans had extra fees, while IRA’s “were free or had no fees,” when, in fact, IRAs are usually the more expensive choice. In many cases, advisors made rollovers more attractive by offering to fill out the paperwork for customers, or by providing a cash bonus for opening an IRA. Some investment firms, according to the GAO report, offered financial or other incentives to advisors who successfully convinced people to accept a rollover.

Brokers can also face intense pressure from their employers to sell in-house products, regardless of whether they serve an investor’s best interests. At JPMorgan Chase, employees who resisted that kind of pressure were “told to change their tactics or be pushed out,” according to a March 2013 article in the New York Times.

In today’s world, workers and retirees face investment decisions that are, at once, deeply confusing and crucially important. In the absence of fiduciary standards, many people will put their trust in salespeople masquerading as trustworthy financial advisors. And many will make huge mistakes as a result – mistakes that can cost tens or even hundreds of thousands of dollars over a lifetime. A disproportionate share of those costs, moreover, will be borne by the middle-income workers whose welfare the brokers and their spokespeople claim to be concerned about.

It should be noted that we are talking, to a large extent, about taxpayer-subsidized retirement accounts. The point of the subsidies is to help people save for a secure retirement and get the maximum value out of the money they set aside, not to produce a windfall for financial professionals. (Employers, according to a recent AARP survey, overwhelming support the concept of a fiduciary duty standard for all those who advise workers on 401(k)-related decisions.)

This one simple step has the potential to deliver large benefits to retirees and investors. It is also, very plainly, the right thing to do. When retail investors seek advice from a financial professional, they generally assume that the professional is acting on their behalf. It makes no sense to insist that some professionals live up to that expectation, while letting others exploit it.

Jim Lardner

Originally published on USNews.com.

Underwater America: Where the Share of Underwater Mortgages is Highest

A new report from UC Berkeley’s Haas Institute challenges the notion of a national housing recovery. While overall rates of foreclosure and mortgage delinquency have fallen since the height of the housing crisis, many areas of the country have yet to see much improvement, according to Underwater America: How the So-Called Housing ‘Recovery’ is Bypassing Many Communities.”

At the end of 2013, the report points out, some 9.8 million Americans – more than a fifth of all homeowners with a mortgage – remained underwater, owing more than their homes were worth. Because homeowners with negative equity are significantly more likely to default than are homeowners with positive equity, these findings make it clear that a great many families still face a high risk of losing their homes.

Ten percent of Americans live in the 100 cities with the most troubled housing markets – cities where, according to the report, between 22 and 56 percent of homeowners are underwater. Those cities include Hartford, Conn. (with a 56% underwater rate); Newark, N.J. (54%); Elizabeth, N.J. (52%); Paterson, N.J. (49%); and Detroit, Mich. (47%).

The report also identifies the 15 metropolitan areas and 395 ZIP codes with the highest incidence of underwater mortgages. The hardest-hit zip codes, many with underwater rates above 60%, can be found in Georgia, Michigan, Texas, Nevada, and Connecticut. (See tables of hardest-hit areas.)

The report concludes that far more needs to be done to prevent foreclosures and mitigate the damage to families and communities. It calls for greatly expanded use of principal reduction, recommending several policy paths to that end.

— Rebecca Thiess

A Rule to Rein in Wall Street Pay Is Too Weak and Way Behind Schedule

Three and a half years have passed since the 2010 passage of the Dodd-Frank financial reform legislation. While some important elements of the law have been implemented (the Consumer Financial Protection Bureau has been hard at work, for example), other provisions simply seem to have been ignored. One crucial reform, targeted at Wall Street’s “heads I win, tails you lose” culture of lavish pay and nonexistent accountability, remains in bureaucratic limbo.

There’s no question that the flawed incentives in Wall Street pay packages played a major role in creating the financial crisis. The Financial Crisis Inquiry Commission, the official body charged with investigating the causes behind the financial and housing market crashes, found that pay systems too often encouraged “big bets” and rewarded short-term gains without proper consideration of long-term consequences. The practice of awarding large bonuses and other forms of immediate compensation creates incentives to ignore long-term risks and “take the money and run.”

Former Securities and Exchange Commission Chair Mary Schapiro described the situation to the commission in this way: “Many major financial institutions created asymmetric compensation packages that paid employees enormous sums for short-term success, even if these same decisions result in significant long-term losses or failure for investors and taxpayers.” To take just one example, top executives of Bear Stearns and Lehman Brothers – the two big investment banks whose failure triggered the crisis – got paid $2.5 billion in the years leading up to the financial collapse. Despite their firms’ disastrous collapse, they got to keep every dime of it.

Risk-taking of this sort wasn’t always how things worked on Wall Street. In the decades after World War II, many of the big investment banks were private partnerships, meaning that senior managers’ funds were constantly at risk and they could only collect their full payouts upon retiring, as opposed to in annual bonuses or stock options. During the decades after the war, in fact, pay inside the financial industry was roughly equal to pay outside of the industry. However, when investment banks went public in the 1980s and 1990s, bets were increasingly made with the money of shareholders, and firm pay structures began to reward the risk-taking that would lead to short-term paydays for companies, at the price of longer-term stability.

The Dodd-Frank financial reform law includes a specific provision to address precisely this problem, but it hasn’t been implemented yet. Section 956(b) of the law requires that financial regulators ban any type of incentive pay arrangements at banks that act to encourage inappropriate risk-taking. The statute tells regulators to write rules to implement the ban within nine months of the signing of the law. Yet today, almost four years after the law was passed, regulators still have not put these required restrictions on Wall Street pay in place.What’s more, not only do the rules remain unfinished, but the initial proposal by the regulators was much too weak to get the job done. The regulators initial proposal to implement Section 956(b) includes general language telling bank boards of directors to design pay packages that don’t encourage excessive risk. But the major specific requirement in the proposal is that large banks set aside at least half of bonus payments to be paid out over three years. To comply with this requirement, a bank could pay their executives half of their bonus at the time it was earned, and then another third of the remaining half the next year, another third the year after that, and a final third three years after the bonus was earned. So as little as one-sixth of the total bonus could be deferred for the full three year period. This new requirement is weak compared to old partnership incentives that held executives’ wealth genuinely at risk based on the long-term consequences of their actions.

Furthermore, the rule doesn’t even ban the practice of “hedging” future compensation – so, for instance, an executive due a future deferred bonus who wanted to receive most of their money immediately could just sell the right to the deferred portion of the bonus in exchange for an up-front payment.

Finally, the specific pay requirements in the proposal cover only “executive officers,” which includes only the CEO and major division heads of the bank, not the traders or other high-level employees below them. This is much too narrow. Individuals who are not covered could include many key decision-makers with the power to incur dangerous risks for the banks.Since the release of this inadequate proposal, there has been no further action on implementing this crucial piece of financial reform. Why has the rule been so delayed and (so far) so weak? One answer is heavy lobbying. As Public Citizen noted in a 2011 report on the pay rule, companies that would be impacted by the new rules have spent hundreds of millions of dollars lobbying against its implementation, along with submitting comments in support of substantially weakening the rule. Another factor is the need for six different regulatory agencies to sign off on the rule, a process built for delay.

Today, the types of pay structures and incentives that contributed to the financial collapse are still in place. The six agencies responsible owe it to the public and the health of the financial system to take action to change them.

— Marcus Stanley and Rebecca Thiess

Originally published on USNews.com.