Global Insight Perspective | |
Significance | If Treasury Secretary Henry M. Paulson's plan is adopted, it would see the merger or elimination of some of the United States' longest-standing institutions. |
Implications | The plan is designed to streamline the regulatory framework and help it focus on the key stresses in the modern financial apparatus. The Federal Reserve would be strengthened and take charge of financial system stability. |
Outlook | Given the political realities, the proposals are only the start of what will be a long debate, and what finally emerges could bear little resemblance; the time span means there will be little direct impact on the current crises. |
Sweeping Overhaul
Former Goldman Sachs head Henry M. Paulson yesterday unveiled what would be an historic regulatory overhaul, radically changing long-standing institutional structures. Treasury Secretary Paulson's plan recognises how integrated the financial system has become, and spans areas such as the markets, banks, non-bank financial institutions, and mortgage lending. The proposals have been given urgency by the current financial crisis, but the boldest measures are medium-to-long term and will not have an immediate impact. It should also be noted that the proposals do not deal with the housing market crisis directly, which is being addressed by separate reform proposals. There is also a range of proposals afoot to deal with the immediate financial market problems. Paulson envisions his proposals entering force in three stages:
- Stage One—Short-Term: The President's Working Group on Financial Markets would be expanded, including banking regulators who do not currently participate. The focus would be broadened beyond the financial markets to the whole financial sector. A new Mortgage Origination Commission would be established, setting minimum licensing standards and grading each state's system. The Federal Reserve's powers would be expanded to allow on-site examinations of non-bank institutions that have access to federal funding. It would be able to place conditions on them.
- Stage Two—Intermediate: The Office of Thrift Supervision, which currently oversees savings and loan institutions, would be closed down. Its responsibilities would fall under the Office of the Comptroller of the Currency, which currently oversees national banks. A study would be undertaken to determine whether state-chartered banks should be overseen by the Federal Reserve or the Federal Deposit Insurance Corporation (FDIC). The Fed would take authority over payment and security transfer systems. An Office of Insurance Oversight would be formed within the Treasury to look at the insurance industry. The Commodity Futures Trading Commission and the Securities and Exchange Commission (SEC) would be merged.
- Stage Three—Long-Term: A new financial regulatory system would be created. The Federal Reserve would be given the function of market stability regulator; it would assess overall stability and could demand changes if this is infringed. There would also be several new federal agencies: the Prudential Financial Regulatory Agency would regulate those financial institutions that have explicit government guarantees; the Conduct of Business Regulatory Agency would oversee consumer protection across all financial firms; the Federal Insurance Guarantee Corporation would replace the FDIC and would charge premiums to guarantee bank deposits and insurance payouts; and finally the Corporate Finance Regulator would assume SEC functions such as corporate governance oversight.
Criticism Mounts Rapidly
Paulson will not be surprised to see a backlash is already under way over his controversial plans. There are many orthodoxies challenged in the proposals and there will inevitably be resistance from officials in agencies that face closure or dramatic change. However, there is also a growing chorus of criticism from those outside government, and it seems a long and arduous debate is in prospect. Getting legislation through the U.S. system intact is very difficult at the best of times—there are sure to be many changes before any longer-term regulatory overhaul sees the light of day. Paulson is moreover unlikely to be in office to see through the plans: a new president takes office in January and he/she could well be a Democrat. Both remaining Democratic hopefuls, Senators Barack Obama and Hillary Clinton voiced doubts about the plans yesterday (see below). The current difficulties of the financial markets are nonetheless focusing minds and this means that, if handled astutely, the changes could progress much more quickly than normal. Most of the significant reforms of the presidency of George W. Bush have been achieved when the country is in crisis recovery mode (for example, anti-terrorism powers after the attacks of 11 September 2001, and tighter corporate regulation in 2002 following Enron and other scandals).
The following are some of the key strands of criticism heard to date:
- State prosecutors are concerned that a national insurance regulator will not be as vigilant in its oversight as they are able to be at present. Their argument echoes wider concerns about whether it makes sense to take swathes of regulation out of state hands and place it at the more distant federal level. These critics argue the Fed failed its recent tests and that it could have seen off the current financial problems earlier.
- The Democratic presidential hopefuls yesterday argued that the proposed new federal regulators are not being given enough teeth. They did, however, join Republican candidate John McCain in backing the idea of a streamlined regulatory structure. In contrast to the state prosecutors, the candidates are in favour of consolidating regulation at the federal level, and giving the Fed a stronger role. This way it would have been better able to cope with the current crisis, they argue.
- In the short-to-medium-term phase, the plan may actually end up creating more bureaucracy than it does away with. It is feasible that the mortgage commission could be created this year, for example, but that the longer-term rationalisation might never come about. The President's Working Group on Financial Markets is also set for expansion in the short term.
- Smaller banks are worried that the proposals are tailored to the needs of the biggest banks and that the impact on them is not taken into account. The large banks have been closely involved in discussions with Paulson and Treasury officials, but it is important the smaller players are won over given their political clout in Congress. The small banks fear the changes will hasten consolidation and the concentration of the sector in a few key players.
- Credit unions are concerned that a single depository regulator will force them into a structure dominated by traditional banks.
- Consumer groups argue that long-term financial sector reform should not take up Congress's time while there is an immediate crisis for millions of homeowners.
Outlook and Implications
Looming large over the debate are the ages-old political fault-lines over the role of the government in the economy. The Republicans champion light intervention and regulation, while the Democrats typically see a greater need for the government to intervene to curb market excesses. Paulson's proposals do not necessarily fall into either camp, but the two sides are already making their voices heard. The equally long-standing debate on the role of states versus federal government has also been ignited.
Whether or not the proposals make quick legislative progress depends, to a large degree, on the reaction of the Democrats, as they currently control Congress and could well win the presidency come November. The Democratic chair of the House Financial Services Committee, Barney Frank, has already poured cold water on the idea of passing the reforms this year. He argued yesterday that lawmakers need to prioritise the housing-market problems. Obama and Clinton have indicated that they are in favour of wide-ranging reform of the institutions, but the doubts they raised yesterday suggest they see this as a longer-term project. The pace of progress will also depend to a large degree upon perceptions of the current crisis. If banking stability improves over the remainder of the year the sense of urgency will be lost.