Rethinking Financial Regulation

by Faiz Shakir, Amanda Terkel, Matt Corley, Benjamin Armbruster, Ali Frick, Ryan Powers, and Ian Millhiser

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Today, the Obama administration is rolling out its plan for reforming the financial regulation system. In an effort "likely to result in the most sweeping overhaul since the 1930s," the administration intends to address some of the regulatory gaps and oversights that contributed to the current economic crisis. "The goal is to integrate the system, make sure that there are not any gaps, and to make sure that we have a[n] updating of the regulatory system that worked back in the 1930s, but doesn't work with the kinds of financial instruments and the kinds of global capital markets that exist today," President Obama told Bloomberg News. The plan will, among other things, set up a structure to monitor systemic risk, develop a new resolution authority for winding down complex non-bank financial institutions, and establish a new consumer protection agency to police financial products. It will also mandate the regulation of derivatives and require financial institutions to retain part of any asset that they securitize and sell. Of course, the banking lobby is gearing up to oppose some of the reforms. "Wall Street seems to maybe have a shorter memory about how close we were to the abyss than I would have expected," Obama said yesterday. "All we're doing is cleaning up after the mess that was made." And even with all of these reforms, the administration will need to ensure that regulators follow through on their responsibilities, which is something that did not occur under the Bush administration.

REGULATING SYSTEMIC RISK: A key part of the Obama administration's plan is the creation of a system for monitoring firms and activities that are large enough to pose a threat to the entire financial system. As the administration explained in a draft of its plan obtained by the Washington Post, "no regulator saw its job as protecting the economy and financial system as a whole. Existing approaches to bank holding company regulation focus on protecting the subsidiary bank, not on comprehensive regulation of the whole firm." To address this, the Federal Reserve would be charged with ultimate responsibility for policing large firms, while other regulators -- including the Securities and Exchange Commission, the Commodity Futures Trading Commission, and the Federal Housing Finance Agency -- would be given "broader coordinating responsibility across the financial system." But there are concerns about burdening the Fed with such a huge additional workload or concentrating too much power in one agency. "We must ensure that we continue to increase our expertise so it is properly matched with the problems and challenges we will face in both our bank supervisory role and in meeting our traditional financial stability mandate," acknowledged Fed Chairman Ben Bernanke. While the plan does call for the elimination of the Office of Thrift Supervision, it otherwise forgoes consolidating regulatory agencies.

ENSURING CONSUMER PROTECTION: A second facet of the plan entails the creation of a new agency that will be tasked with protecting consumers "from deceptive or dangerous mortgages, credit cards and other financial products." The proposed Consumer Financial Protection Agency will have broad powers to regulate the relationship between financial companies and consumers, "including writing rules, policing compliance and penalizing delinquent firms." Currently, regulators are simply too far removed from consumers to get an adequate sense of how financial products are being marketed on the ground level, a problem this council will seek to address. As Professor Elizabeth Warren -- a longtime advocate of a consumer protection council -- said, "[A]ll these lousy mortgages got sold, one family at a time...If we had had just basic safety standards in place from the beginning, then we never would have fed these into the front end of the financial system." But, the banking lobby has already made its opposition to the new agency clear. "It's bad for the consumers," said Steve Bartlett, president of the Financial Services Roundtable, a lobbying group for banks. "Give the power for consumer protection to the agencies that have real power."

WAIT 'TILL NEXT YEAR?: Bloomberg reported yesterday that the financial regulation plan "may be stalled into next year as Congress and the president set health-care reform and climate control as domestic priorities." The Senate reportedly won't even begin to consider the plan until after the August recess. As the Washington Post's Ezra Klein noted, waiting a year means "a solid eight to 12 months in which the broader public can lose interest in financial regulation and the financial industry can ramp up its lobbying effort in the Congress." The Atlantic's Derek Thompson posits that the delay "won't kill the will for financial reform, but it could turn the will into mush." In fact, Obama's regulatory proposals may already have been scaled back "because lawmakers and the public perceive the financial crisis has abated and support for more aggressive options has faded," said Peter Solomon, an investment banker and counselor to the U.S. Treasury in the Carter administration. But in an interview yesterday with the New York Times and CNBC, Obama reiterated that "we want to get this thing passed, and, you know, we think that speed is important. We want to do it right. We want to do it carefully. But we don't want to tilt at windmills." Obama reportedly wants to sign a bill this year.