Last Wednesday, the Obama administration released its already controversial 89-page blueprint, “Financial Regulatory Reform: A New Foundation.” As President Barack Obama anticipated in his speech unveiling the plan, some people argue that it goes too far as a massive government intervention and others argue that it does not go far enough as top-to-bottom essential reform. This is not surprising since it emerged after the Obama administration shrewdly recognized the political and bureaucratic constraints on the legislation that can be enacted by Congress.
But everyone agrees that this plan to make the financial system more resilient and stable is the most radical one since the 1930s under the New Deal that followed the Great Depression. It is, however, nowhere as radical as the sweeping overhaul of the financial system pushed by President Franklin D. Roosevelt as part of his New Deal. Given its wide scope and lengthy exposition, the Obama plan also reads and sounds more radical than it actually is. I believe that the plan had to be pragmatic, a skillful but inelegant compromise, leaving largely intact the complex balkanized system of overlapping regulatory agencies so that it could survive the political and bureaucratic turf battles that lie ahead.
The Obama plan “white paper” contains a biased analysis of what caused the global financial crisis. It puts too much blame on the private sector and not enough on government policies that were also responsible. It admits that the crisis had multiple causes but argues that the most critical one was the failure of prudent financial supervision and regulation. The plan has five major objectives:
1- “Promote robust supervision and regulation of financial firms.” The premise here is that any financial institution that poses a systemic risk should be subject to strong oversight and supervision. Although this task is assigned to a new Financial Services Oversight Council of financial regulators, an interagency group chaired by the Treasury, the Federal Reserve (Fed) would play the major role. The plan requires for this task tougher capital and other prudential standards as well as the registration of advisers of hedge funds and other private equity groups.
2- “Establish comprehensive supervision of financial markets.” The premise here is that all major financial markets should be able to withstand both systemic stress and the collapse of any large financial institution. Toward that objective, the plan proposes better regulation of securitization markets through greater market transparency, the more effective regulation of credit-rating agencies and the requirement that issuers and originators retain 5 percent financial interest in securitized loans. The plan also foresees the comprehensive regulation of all over-the-counter derivatives, including credit default swaps, as well as the supervision by the Fed of payment, clearing and settlement systems.
3- “Protect consumers and investors from financial abuse.” The premise here is that consumers' trust and confidence in the financial system and their ability to understand the financial products and services, such as annuities, mortgages and credit cards, they buy are crucial to financial stability. The plan, drawing from the new field of behavioral economics and finance that emphasizes the shortcomings of the rational decision-making model by individual consumers and investors assuming full information, aims at protecting them from “unfair, deceptive and abusive practices” through a new Consumer Financial Protection Agency that would consolidate the consumer-protection provisions currently split among seven regulatory agencies.
