The first thing to keep in mind when appraising the President’s new regulatory scheme for the financial sector is that it is merely the administration’s wish list, with Congress yet to be heard from.
That said, there is a reasonable chance that Obama will get much of what he called for in Wednesday’s speech. For two reasons: the recent near-melt-down of the financial sector has revealed weaknesses in the regulatory structure, and the President has been careful to treat politics as the art of the possible.
He knows that every regulator reports to some congressional committee or committees, and that congressional barons are more than a little reluctant to give up power, which they have to do if the agency they oversee is eliminated or pared down. So initial plans to consolidate agencies have been severely modified, with only a few to be merged — and not the most important ones.
The President has gone to great lengths to calm fears that he is unduly restricting the freedom of action of financial institutions. “You set up some rules of the road, ensure transparency and openness, guard against huge systemic risk that will lead…government potentially having to step in to avoid a depression, and then let entrepreneurs and individual businesses compete and do what they do.” More on that in a moment.
Start with the securitization process, which many believe converted a problem in the mortgage markets into a threat to the entire financial system. Geithner is eager to get the securitization process restarted, so that credit will flow more readily to the business community and consumers.
So he persuaded the President to take the quite sensible step of requiring those selling these securities to have some skin in the game — retain 5% of the value of such securities. This means the issuer/ peddler remains at risk, and is less likely to push dicey paper out into the market. Here, the administration has followed the first principle of good regulation: get the incentives of the private-sector players aligned with the broader public interest.
The administration is also right to call for reform of the rating system to eliminate the conflict of interest inherent in the fact that agencies get paid by issuers only if the deal gets done. No surprise, then, that the holy water of AAA ratings was sprinkled liberally over a great deal of paper that proved to be toxic, in some cases fatally so. Perverse incentives in action.
Then there is the Securities and Exchange Commission (SEC), an agency that did not cover itself with glory during the boom years — think Bernie Madoff. Obama proposes to transfer the SEC’s power to regulate financial products flogged to small customers, including credit cards, student loans, and home mortgages to a new Consumer Financial Protection Agency, and to a beefed-up Federal Trade Commission. Inter-agency squabbles to follow.
Most important, the previously independent Federal Reserve Board will have new powers, but will now have to cope with a political overseer — the Treasury. Obama wants the Fed to be given new powers to oversee not only banks but any financial institution the failure of which would create systemic risk.
Caught in the net would be GE Capital, the finance arm of GE, which is larger than many banks, and any hedge funds and private equity groups that might become large enough to fall into the “too big or interconnected to fail” category.
But like other agencies, the Fed would report to a new Financial Services Oversight Council, housed at the Treasury, with “a permanent full-time staff” to provide the Fed and other regulators with the information they need to do their jobs, never mind that these agencies have their own staffs to provide such data. There is a lot more, including a proposal that regulators be allowed to seize failing institutions.
The net effect will be an increase in capital requirements as the Fed exercises its new regulatory powers — which means lower profit margins for banks; new regulation of non-bank financial institutions; greater power for the Treasury and, therefore the politicians who have the power to appoint and approve its key personnel; and a flood of new regulations as the plethora of regulators churn out specific rules designed to give flesh to the President’s skeletal outline — a fact of which Obama is well aware, and why his attempt to present his proposals as minimally intrusive and “light handed” should be taken with the output of a large salt mine..
Examiner Columnist Irwin M. Stelzer is a senior fellow and director of the Hudson Institute’s Center for Economic Studies
