Although the Bush administration has been criticized for its largely hands-off approach to the housing crisis, Treasury Secretary Henry Paulson can now take credit for having accomplished one of the most difficult feats in the financial services universe: getting people excited about bank regulation. While interest is usually limited to a wonky collection of lawyers, bankers, and economists, the issue leaped into the national spotlight over the weekend as details of Paulson's "Blueprint for Regulatory Reform" leaked into the national media. The proposal would attempt to modernize the financial services regulatory structure to meet the demands of today's complex financial ecosystem. Here's what you need to know about it:
What are the key changes Paulson has proposed?
Overhaul regulation: The current financial services regulatory structure is based on an inefficient patchwork of regulatory agencies. Paulson's "blueprint" includes a plan to create a more streamlined regime featuring these three distinct bodies:
- Market stability regulator (the Federal Reserve): Under the plan, the Fed would be given sweeping new powers and evolve into a "market stability regulator." In essence, the agency would become the police chief of the entire financial services industry and focus on ferreting out practices at all sorts of financial firms—from tiny banks to hedge funds—that threaten to derail the stability of the system. "The Fed would have the authority to go wherever in the system it thinks it needs to go for a deeper look to preserve stability," Paulson said today in a speech unveiling the plan. (The agency would also retain its monetary policy authority.)
- Prudential financial regulator: The plan also calls for a single regulatory body for banks, which are currently supervised by five separate federal agencies. One such agency, the Office of Thrift Supervision, would be eliminated altogether.
- Conduct of business regulator: Paulson also proposes the establishment of an agency dedicated to protecting consumers and investors. The agency is intended to bring consistency to "regulation where overlapping requirements currently exist," Paulson said. "Mortgages are an example of a consumer financial product that has suffered from uneven and inadequate treatment in our current regulatory and enforcement regime."
Merge the SEC and the CFTC: Paulson calls for the Securities and Exchange Commission and the Commodity Futures Trading Commission to be brought together under one roof.
Create the Mortgage Origination Commission: The plan also includes a proposal to create a new commission to oversee—but not replace—the state-based regulatory structure of the mortgage origination industry. This new body—the Mortgage Origination Commission—would set standards for industry participants and rate each state's regulatory framework.
Federally charter insurance companies: In addition, the blueprint would rework the insurance regulatory structure by giving companies the option of a federal charter, just as banks have. Currently, insurance companies are regulated by the states in which they operate. Because laws vary from state to state, the structure can be burdensome.
Why is the plan being introduced now?
The Treasury Department began working on a plan to modernize the financial services regulatory structure about a year ago. The system—a patchwork of state and federal agencies—has long been criticized as bloated and inefficient. "Many banks are regulated by more than one [regulator], so they often get conflicting instructions about compliance," says Christopher Low, chief economist with FTN Financial. "So consolidation or simplification makes sense from that standpoint."
But the idea of modernizing the system has taken on new urgency as the credit crisis has intensified—especially after the Fed allowed investment banks to borrow from its discount window (formerly open only to commercial banks) shortly after the implosion of Bear Stearns, the fifth-largest U.S. investment bank. "That has brought [the issue of financial services regulatory modernization] to the forefront," says Brian Sack of Macroeconomic Advisers.
Will the blueprint be implemented?
Parts of it, sure. But given all the different players involved—lawmakers, regulators, administration officials—a wholesale overhaul of the regulatory structure, while certainly warranted, will be difficult to execute. "Treasury is probably not going to get everything that they asked for," says Lou Crandall, chief economist at Wrightson ICAP. "However, some of these proposals are ideas that have been recognized as good ideas for a long time." Issues closer to the core of the current crisis—such as streamlining bank regulation—will be easier to get through Congress, Crandall says. Issues on the fringes of the crisis, like the federal insurance charter, face longer odds.
When will the changes take place?
Paulson insists that most of these reforms should not be implemented until the current crisis in the credit markets has been resolved. Trying to reform the regulatory structure in the midst of the current market turmoil could make matters worse, he says. "These long-term ideas require thoughtful discussion and will not be resolved this month or even this year," Paulson says. Crandall says it could be years before components of the Paulson plan are implemented. "I don't think there is any doubt that this crisis will lead to landmark financial services regulatory legislation," Crandall says. "[But] it takes a while for the conventional wisdom to gel in Washington."
Would the plan address the current problems in the housing and credit markets?
Nope. The plan was not intended to do so but rather to update the regulatory framework in the hopes of preventing future financial crises, says Dean Baker, codirector of the Center for Economic and Policy Research. Baker, however, is less than enthusiastic about the plan, arguing that it would not have prevented the current crisis even if it had been in place years ago. "It's not clear that the regulators would have the authority to prevent investment banks from taking on the liabilities that not only jeopardized themselves—but in the view of [Fed Chairman Ben] Bernanke and just about everyone else—the whole financial system," Baker says.
Would the blueprint prevent future crises?
Not all of them. Even Paulson admits that better regulation is not a silver bullet. "I am not suggesting that more regulation is the answer," Paulson said. "Or even that more effective regulation can prevent the periods of financial market stress that seem to occur every five to 10 years."
What will the introduction of the plan accomplish?
While an eventual revamping of the financial services regulatory structure may take a different shape than Paulson has proposed, his blueprint is significant because it will get key players talking about the issue, Sack says. "We may end up with a regulatory structure that looks very different," Sack says. "[But] it's a useful first step to [introduce] some ideas about the regulatory framework and work from there."
Sack says that the current regulatory structure probably involved too many players with different and overlapping interests. "It makes sense to rethink that regulation," Sack says. "It's just too bad it took this situation to push that forward."