Regulatory Reform: Obama Administration to Announce Changes

Question is: Exactly How Sweeping Will Those Changes Be?
Regulatory Reform: Obama Administration to Announce Changes
The financial meltdown last fall and the current global recession are only two of the reasons that the White House this week is expected to announce a regulatory reform package. But exactly how much reform will be proposed?

Treasury Secretary Timothy Geithner has left trail of bread crumbs in the past months in his public comments about these prospective changes. Here's what he's revealed so far:

No 'Uber-Regulator' -- On June 9, Geithner told the Senate Appropriations Financial Services and General Government subcommittee that there won't be a single systemic risk regulator. Geithner told the subcommittee that the job of handling systemic risk was too big and too complex for a single agency.

Yes to a Regulatory Council -- In his comments to the same Senate panel, Geithner notes he supports the idea of a regulatory council, something that Sheila Bair, Chair of the FDIC, suggested as an oversight for systemic risk in April. Geithner sees a council "has a lot of merits in that context."

No Action for Fannie Mae/Freddie Mac -- Geithner in his testimony says the administration's regulatory revamping plan, expected to be announced by President Obama, would not include a blueprint for restructuring the two government-sponsored enterprises, Fannie Mae and Freddie Mac. Their fate will be decided later after Congress and the administration review the options of what do with the two entities that own or guarantee about half of the US's $12 trillion mortgage market.

Executive Comp Reform -- Some of the other things that may be present in the regulatory reform package include a move toward curbing executive compensation, as previewed in the speech given by Gene Sperling, Counselor to the Secretary of the Treasury, before the House committee on Financial Services. Sperling outlined five points in his testimony on the risks and consequences of quick compensation without regard to long-term effects on the soundness of the firm.

Derivatives Oversight -- Over the counter derivatives will also see modifications, if Geithner's letter to Senator Harry Reid, is any indication. There he outlines the ideas for reigning in with a regulatory framework an area of securities that has had little to no oversight by regulators.

Consumer Protection -- In an opinion piece in the Washington Post today, Geithner sees the current regulatory framework doesn't offer adequate protections to consumers and investors. Weak consumer protections against subprime mortgage lending bear significant responsibility for the financial crisis. "The crisis, in turn, revealed the inadequacy of consumer protections across a wide range of financial products -- from credit cards to annuities," he writes. Geithner says he wants to build on the recent measures taken to fight predatory lending and unfair practices in the credit card industry and that the administration will offer a stronger framework for consumer and investor protection across the board.

The first proposed legislation that Geithner presented before the House Committee on Financial Services in March provides broad authority over troubled financial institutions. The proposed legislation and other recommendations would significantly affect large non-bank financial institutions, the derivatives markets, and perhaps large hedge funds, and would have a lesser impact on other private investment funds and money market mutual funds.

Last Thursday, the Republicans offered their vision of regulatory reform. Among their proposals: to take away the Federal Reserve Board's powers, establish a single banking regulator and set up a specialized code for bankrupt "too-big-to-fail" non-banking firms.

Observers: How Far and Wide Reform?

The one sure bet is, there will be regulatory restructuring. The question is -- how far will the changes go?

"We'll have a new systemic risk regulator," says Bill Isaac, a former FDIC Chairman, now Chairman of the LECG Global Financial Services, a consulting firm serving the banking industry. "Before when it was first talked about they were saying to make the Federal Reserve the systemic risk regulator." But that's no longer the direction, Isaac observes. "But more on a systemic risk council, headed by the Fed, FDIC, SEC, treasury and others who will meet on a monthly basis," he says. One of the things the council will be looking for are systemic risks that need to be addressed.

The FDIC had requested the formation of a resolution authority to deal with non-bank entities that fail, such as AIG, Bear Stearns and Lehman Brothers.

"While that sounds good in theory, serious political issues come with it," Isaac says. One question is who is going to do it; would it be the FDIC? Though Treasury and FDIC think so, banks are against it. "They've built up the brand and the fund for past 75 years and don't want to dilute it," he notes. One way around that is to create a separate authority, and let the FDIC oversee it. The other thorny problem would be to identify those systemically important companies. The political problems with setting up and funding such a regulator would be enormous, Isaac observed.

Walter Mix, former commissioner of the California Department of Financial Institutions (DFI), has seen regulatory reform and consolidation of the bureaucracy. "I dealt with all this; it's difficult to effect meaningful change, especially at a federal level," he says. Mix is now a managing director in LECG's west coast office, and focuses on bank risk management and corporate governance issues. He is chairman of the International Bankers Association of California.

As far as the jockeying for top regulator position goes, Mix says even the winner may end up with less than they bargained for. "Even if one comes out on top, they may end up having the bullseye painted on them for next time."

Mix leans toward finding a way to keep the dual banking system in place, and he sees the council approach as the best one. "I've worked on the intergovernmental level out here, so some sort of council type of approach is warranted and should be looked at."

One area Mix sees where more regulatory scrutiny needs to be focused is on the international supervision level. "It's lacking. More and more, we're seeing nobody is looking at what was happening at the higher international level, forget what we missed on the US system level."

Systemic Regulator Needed

The most critical change discussed in the regulatory reform proposals is the creation of a systemic regulator to oversee the entire picture, says Scott Talbott, senior vice president for government affairs at the Financial Services Roundtable, which represents the top 100 banks in the US. "The systemic regulator's role would be to oversee the participants in the system to prevent future crises," Talbott says.

Talbott says the other changes such as the proposal to regulate derivatives are needed. "The issue is which ones? There seems to be consensus that 'plain-vanilla' contracts be traded on an exchange, and more personalized contracts are not. The discussion focuses on how to define these terms," he says.

As to the question swirling in investment circles about replacing the division between commercial and investment sides, such as the separations enacted with the now repealed Glass-Stegall Act, Talbott notes that in general the regulators have increased capital requirements for financial services firms. "These new capital requirements will remain for the foreseeable future."

The ultimate goal is to modernize and strengthen the US and the global regulatory frameworks to prevent or minimize future crises. "We believe that regulatory reform can be accomplished this year," Talbott says. "Our advice to the industry is to weigh in with policymakers with ideas for making the system stronger."


About the Author

Linda McGlasson

Linda McGlasson

Managing Editor

Linda McGlasson is a seasoned writer and editor with 20 years of experience in writing for corporations, business publications and newspapers. She has worked in the Financial Services industry for more than 12 years. Most recently Linda headed information security awareness and training and the Computer Incident Response Team for Securities Industry Automation Corporation (SIAC), a subsidiary of the NYSE Group (NYX). As part of her role she developed infosec policy, developed new awareness testing and led the company's incident response team. In the last two years she's been involved with the Financial Services Information Sharing Analysis Center (FS-ISAC), editing its quarterly member newsletter and identifying speakers for member meetings.




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