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Treasury Secretary Henry Paulson's proposed sweep of financial regulation would emphasize more control at the federal level, at the expense of state oversight, and consolidate an alphabet soup of existing agencies.
It is an idea that has been kicking around for a while, and one that is bound to provoke heated debate on Capitol Hill and among the various banking and market oversight agencies, which are already tripping over each others' turf. It is also bound to please some circles of Wall Street because the plan, while strengthening the Federal Reserve's role over certain aspects of the markets, like risk taking, would also emphasize greater self-regulation over other aspects, including business conduct.
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Paulson's plan is a recognition that Wall Street has pushed beyond regulators' abilities to keep up with innovation. Asset securitization and other structured finance activities, where the credit crisis was created, didn't exist at the time the federal banking agencies were established decades ago. And since the repeal of Depression-era laws separating risky brokerage activities from consumer deposit safeguarding, Wall Street and major commercial banks have increasingly been competing in trading, stock and bond underwriting, and other risk-taking activities.
Even the markets have morphed. The major
Wall Street's main lobby group, the Securities Industry and Financial Markets Association, embraced Paulson's proposals. "Our present regulatory framework was born of Depression-era events and is not well suited for today's environment where billions of dollars race across the globe with the click of a mouse," said Tim Ryan, chief executive of the association. "That fact, teamed with the current market conditions, result in an universal agreement that it is time to modernize and revitalize the current system."
Paulson proposes combining federal bank and thrift regulators, creating a federal insurance regulator and merging the Securities and Exchange Commission with the Commodities Futures Trade Commission. He also recommends the creation of a Mortgage Origination Commission to oversee the licensing of mortgage lenders.
But he potentially dilutes the power of state regulators by emphasizing greater authority for a new federal deposit institution regulator. State power to regulate banks has been waning in the last decade as major institutions switched their licenses to federal charters to take advantage of less restrictive consumer privacy and other regulations at the federal level.
And it comes as existing federal agencies are scrambling to respond to the crisis amid tighter budgets. The Federal Deposit Insurance, for example, is increasing its staff 60% to prepare for an expected wave of bank failures. On Friday, it cracked down on another mortgage lender, ordering troubled California-based Fremont General to raise capital or sell its bank subsidiary in 60 days.
In insurance, where regulation is entirely at the state level, a proposed federal regulator is bound to provoke opposition.
The plan is the result of a study Paulson commissioned last June, just before the markets started to implode. In transferring more authority over the markets to the Federal Reserve, the plan tries to close gaps in regulation that helped create the current credit crisis, including the fact that many of the subprime mortgage lenders that contributed to the housing bubble operated outside the grasp of banking regulators.
Reform took on more urgency earlier this month when the Fed and Treasury intervened in the collapse of Bear Stearns, pushing it into a merger with JPMorgan Chase to avoid a bankruptcy filing and a potentially cataclysmic rush to sell assets.
No one is saying the system should stay the same, that's for sure. But so far the Bush administration's proposals have stopped short of much stricter, or even permanent, oversight of investment banks. Even Paulson's plan would limit the Fed's oversight of Wall Street firms to times of extreme market stress, when investment banks approach it to borrow money directly, as they are now allowed to do. And it would preserve, if not enhance, the power of self-regulatory organizations like the major stock exchanges to police market conduct themselves.
Critics of the current system have argued that there are too many ways for ill-intentioned market participants to operate around existing rules. Democrat Charles Schumer, a member of the Senate Banking Committee, said in a statement late Friday, "In broad outlines, we agree with large parts of Secretary Paulson's plan. He is on the money when he calls for a more unified regulatory structure." But the
Last week, Massachusetts Congressman Barney Frank said Congress should authorize the Fed to act as a risk regulator across the markets. "To the extent that anybody is creating credit, they ought to be subject to the same type of prudential supervision that now applies only to banks," he said.
By Liz Moyer