Financial Reform's Uncertain Impact on Main Street

Figuring out all the possible consequences of the 2,000-page financial reform bill approved by Congressional negotiators on June 25 can be daunting. While such specific targets of the bill as Wall Street firms have long been deciphering exactly what it means for them, many Main Street investors—and the professionals who serve them—have focused only on the legislation's broader potential effects.

The compromise on the Dodd-Frank bill was unveiled just as 1,350 financial advisors, mutual fund managers, and other investing professionals were wrapping up the annual, three-day Morningstar Investment Conference (MORN). Giving the conference's keynote speech on June 24, Vanguard President and Chief Executive Officer William McNabb said reform is necessary to restore the trust of investors, which is at "all time lows."

President Barack Obama has said he would like to receive a Congressionally approved bill by July 4. "That's a good thing," said McNabb, "if we are going to restore the trust investors deserve."

McNabb said he supported provisions that could require all financial advisors, including brokers, to follow the same rules with regard to protecting their clients' interests and disclosing how they're compensated. "It would be a really good idea for investors to know that everyone is following the same standards," McNabb said.

Another positive consequence of reform for investors would be the lifting of the uncertainty that has hung over financial companies. Executives and investors alike have been unsure how financial reform could affect these businesses.

the best thing? "it is over"

"Clarity is good," said Christine McConnell, a fixed-income portfolio manager at Fidelity Investments. Once financial institutions "understand the rules of the road," she said, "they'll be able to accommodate their business models" to them.

Many in the investment industry agree, even as they worry about other effects of reform. "The best thing we can offer about the final bill is that it is over," Stifel Nicolaus (SF) analyst Chris Mutascio wrote in an otherwise critical note about the reform deal.

"Clearly there were regulatory breakdowns," says Michael Hasenstab, portfolio manager of the Templeton Global Bond fund (TPINX), in an interview. He adds: "we need to be careful [about] unintended consequences."

One unintended consequence of reform could be higher fees for bank customers and consumers.

Financial sector analyst Dick Bove of Rochdale Securities told Bloomberg on June 25 that banks would be able to pass on the costs of reform to their customers. "The industry has been pummeled because everybody believed that banks caused the financial crisis," Bove said. "That pummeling is over."

tighter regulation, tighter credit?

The ultimate effect of the bill on banks' behavior remains unclear. Mutascio warned that it could force banks either to take on more risk to recoup earnings diminished by reform or to behave too conservatively in order to avoid losses. "Pick your poison—neither tastes good to us and we believe neither is particularly good for the economy and job growth," he wrote.

As a general matter, "tighter regulation [is] a tightening of credit," Curtis Arledge, chief investment officer for fixed income at BlackRock, said at the Morningstar Conference. Tighter credit could slow the economic recovery.

"Are banks going to become [like] utilities, only able to lend in a more conservative way?" Arledge asked. Long term, "that would dampen growth but lead to … a more stable system."

In contrast, McConnell thinks that in the short term, there could be a loosening of credit by banks. Banks have already been restricting their lending while they waited for the financial reform's final details. If a bill becomes law, "you would expect lending to pick up," she says.

Industry professionals would like to see the investing public's faith in the financial system restored by reform. If accomplished, that could help bring customers' dollars back to their funds. However, a restoration of trust is only worthwhile if reform is not too costly to the economy—and to investors' pocketbooks.

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