Obama’s opening shot

America’s regulatory reforms

Obama’s opening shot
Jun 17th 2009 | NEW YORK
From Economist.com

Barack Obama’s financial overhaul is bold in some parts, timid in others

 

 

 

HAVING spent much of the past year putting out fires, America’s leaders are now turning their attention to preventing future blazes. Barack Obama unveiled proposals on Wednesday June 17th that would refashion the federal rules governing almost every corner of finance, pushing government much more deeply into private markets and partially rolling back a quarter-century of liberalisation. Eye-catching though the 85-page “white paper” is, it might have been bolder. It merely sounds the opening salvo in a battle that could stretch into next year, because much of the plan requires approval in Congress, where jurisdictional and ideological clashes beckon.

 

The emphasis is on closing gaps that allowed risk to build in the shadows. Supervision of all firms big enough to threaten overall stability will be consolidated under the Federal Reserve. These entities will be made to hold more capital and liquidity than smaller firms, though all will face higher requirements (to be determined after a report at the end of this year). The Fed will be advised by a council of regulators that will also scan the horizon for emerging risks. Another priority is the construction of a mechanism to wind down any failed financial giant, not just banks, as is the case now, so that officials no longer face an unenviable choice between bail-outs (American International Group) and system-shaking collapse (Lehman).

 

The net is also being cast over markets whose freewheeling growth contributed to the crisis. Those who package loans together for sale in securitisations will have to disclose more and, more importantly, keep 5% of any deal to encourage sounder underwriting—although the ban on hedging that exposure could be tricky to enforce. Sensibly, the plan calls for payment of their fees to be spread over time and reduced if the loans explode. It also builds on earlier proposals to rein in over-the-counter derivatives, such as credit-default swaps. Those not cleared centrally or traded on exchanges face higher capital charges.

 

Perhaps the most eye-catching—and certainly the most populist—measure is the creation of a Consumer Financial Protection Agency (CFPA). Taking some powers from the Federal Reserve and other bank regulators, this would have broad rule-writing and enforcement powers in mortgages, credit cards and the like.

 

In light of the “liar loans” and other nasties that proliferated in recent years, it is hard to argue against an overhaul of such regulation. Still, concern is already mounting that the new agency will take an overly restrictive view of permissible products, limiting access to credit and curbing good as well as bad innovation. Others worry that it will have less leverage than safety-and-soundness supervisors over banks that peddle dodgy products.

 

A bigger concern is Mr Obama’s failure to rationalise America’s tangled, archaic mess of regulatory bodies. True, the Office of Thrift Supervision (OTS), which oversaw disasters such as Countrywide and Washington Mutual, will be subsumed into another agency, but that still leaves four federal bank regulators, plus state agencies, and these will have to work alongside the CFPA. “The alphabet soup has lost three letters and gained four,” moans one banking consultant.

 

Dropping the idea of a single bank regulator and a merger of the agencies that oversee securities and derivatives, both of which were early Obama goals, was, say officials, a cold-blooded calculation based on the strength of political opposition. This could come from congressional leaders, such as Barney Frank, who have cooled to the idea of a unified regulator in the wake of Britain’s unhappy experience with the FSA. It could also come from the committees that police, and take contributions from, banks and exchanges.

 

Leaving the framework largely intact is risky. The current set-up is not all bad, to be sure: one regulator may spot a problem that another misses. But, even with the OTS gone, banks will be able to shop for friendly charters. Disagreements between agencies over the dangers lurking in commercial property led to a delay in urging banks to tighten standards. And inter-agency feuding has been growing: witness the skirmishes between the Federal Deposit Insurance Corporation’s Sheila Bair and other regulators over deposit insurance and their treatment of Citigroup. In a sign of lingering concerns over such squabbles, the new systemic-risk council will be given the job of resolving disputes between agencies.

 

Other punches have been pulled, too. For big insurers, frustrated at having to be regulated state by state, the wait for an optional federal charter goes on. Nor were concrete proposals offered on money-market funds, runs on which greatly added to the trauma following Lehman’s demise. Officials argue, with some justification, that these omissions are sound tactics: Congress can swallow only so much esoteric reform in one go, even after a hundred-year flood.

 

Even without these measures, the white paper may get beaten black and blue. There is unease on Capitol Hill over an expanded role for the Fed, continued balkanisation and much else. Bank lobby groups support systemic regulation but will waste no time trying to water down the consumer agency and persuade lawmakers that higher capital requirements will curb lending to hard-working Americans (and put the industry at a competitive disadvantage without international harmonisation). Moreover, the reforms must jostle with health care and energy for legislative time, leaving some doubting their chances of passing in any form until next year. As uncharacteristically exciting as financial regulation has become, even bigger thrills may lie ahead.