The White Paper on Financial Market Regulation

The White House today announced the publication of the long-awaited Treasury Department White Paper on Financial Regulation. Here's the summary, with commentary in red:

(1) Promote robust supervision and regulation of financial firms. Financial institutions that are critical to market functioning should be subject to strong oversight. No financial firm that poses a significant risk to the financial system should be unregulated or weakly regulated. We need clear accountability in financial oversight and supervision. We propose:

• A new Financial Services Oversight Council of financial regulators to identify emerging systemic risks and improve interagency cooperation.

• • Instead of consolidating financial regulators, so as to eliminate forum-shopping, duplication, inconsistent regulation, and all the other problems associated with the regulatory alphabet soup, we're going to create a new regulatory body and an additional layer of regulatory hierarchy. We're making the system more rather than less complex.

• New authority for the Federal Reserve to supervise all firms that could pose a threat to financial stability, even those that do not own banks.

• • A massive expansion of Fed power and a massive expansion of government power to regulate the economy. Also dubious, because the Fed's expertise does not extend to regulation of non-banking industries.

  • In the long run, it may threaten the fed's independence. Query whether Congress will tolerate the Fed meddling in industries of local importance to powerful committee chairs.

• Stronger capital and other prudential standards for all financial firms, and even higher standards for large, interconnected firms.

• A new National Bank Supervisor to supervise all federally chartered banks.

• Elimination of the federal thrift charter and other loopholes that allowed some depository institutions to avoid bank holding company regulation by the Federal Reserve.

• The registration of advisers of hedge funds and other private pools of capital with the SEC.

• •  There is no evidence that hedge funds contributed to the financial crisis nor that regulation of them would have prevented or even mitigated the crisis.

  • Because hedge funds benefit the economy by bearing risks that others will not, engaging in transactions that tend to make securities more liquid, and ferreting out market inefficiencies, stricter regulation of hedge funds could do more harm than good. See Shadab on The Challenge of Hedge Fund Regulation.

  • Bear in mind that Bernie Madoff was a registered investment adviser, much good that did.

(2) Establish comprehensive supervision of financial markets. Our major financial markets must be strong enough to withstand both system-wide stress and the failure of one or more large institutions. We propose:

• Enhanced regulation of securitization markets, including new requirements for market transparency, stronger regulation of credit rating agencies, and a requirement that issuers and originators retain a financial interest in securitized loans.

  •  The whole idea of securitization is to enable firms to diversify by shedding originated loans. The problem was that the Lehmans of the world retained too many of their toxic assets. So the last element of this bullet is likely to do more harm than good.

• Comprehensive regulation of all over-the-counter derivatives.

• New authority for the Federal Reserve to oversee payment, clearing, and settlement systems.

(3) Protect consumers and investors from financial abuse. To rebuild trust in our markets, we need strong and consistent regulation and supervision of consumer financial services and investment markets. We should base this oversight not on speculation or abstract models, but on actual data about how people make financial decisions. We must promote transparency, simplicity, fairness, accountability, and access. We propose:

• A new Consumer Financial Protection Agency to protect consumers across the financial sector from unfair, deceptive, and abusive practices.

  • The federal government has long eschewed merit regulation of securities, in large part because it threatens to restrict and constrain innovation. I worry that the new agency will have that impact.

• Stronger regulations to improve the transparency, fairness, and appropriateness of consumer and investor products and services.

• A level playing field and higher standards for providers of consumer financial products and services, whether or not they are part of a bank.

(4) Provide the government with the tools it needs to manage financial crises. We need to be sure that the government has the tools it needs to manage crises, if and when they arise, so that we are not left with untenable choices between bailouts and financial collapse. We propose:

• A new regime to resolve nonbank financial institutions whose failure could have serious systemic effects.

  •   We've got to get away from the moral hazard problem and the probelm of de facto federal guarantees. Making clear that these problems will be resolved in the future via the bankruptcy process would be far more preferable.

• Revisions to the Federal Reserve’s emergency lending authority to improve accountability.

(5) Raise international regulatory standards and improve international cooperation. The challenges we face are not just American challenges, they are global challenges. So, as we work to set high regulatory standards here in the United States, we must ask the world to do the same. We propose:

• International reforms to support our efforts at home, including strengthening the capital framework; improving oversight of global financial markets; coordinating supervision of internationally active firms; and enhancing crisis management tools.

In addition to substantive reforms of the authorities and practices of regulation and supervision, the proposals contained in this report entail a significant restructuring of our regulatory system. We propose the creation of a Financial Services Oversight Council, chaired by Treasury and including the heads of the principal federal financial regulators as members. We also propose the creation of two new agencies. We propose the creation of the Consumer Financial Protection Agency, which will be an independent entity dedicated to consumer protection in credit, savings, and payments markets. We also propose the creation of the National Bank Supervisor, which will be a single agency with separate status in Treasury with responsibility for federally chartered depository institutions. To promote national coordination in the insurance sector, we propose the creation of an Office of National Insurance within Treasury.

Under our proposal, the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC) would maintain their respective roles in the supervision and regulation of state-chartered banks, and the National Credit Union Administration (NCUA) would maintain its authorities with regard to credit unions. The Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) would maintain their current responsibilities and authorities as market regulators, though we propose to harmonize the statutory and regulatory frameworks for futures and securities.

What's striking about this last paragraph is the regulatory cowardice it exhibits. It makes no sense for the SEC and CFTC to remain separate, for example. The only reason they do so is because the SEC is regulated by the Senate Banking and House Financial Services Committee, while the CFTC is regulated by the House and Senate Agriculture Committees. An agency merger would have deprived one of these committees of jurisdiction. The Obama administration was unwilling to challenge the old bulls that run those committees.

Comments

[Michael F. Martin]

I'm still studying the white paper myself, but I think some of the "inefficiencies" you point out in additional hierarchy and overlapping jurisdiction might be put in the same category as the checks and balances that exist under our Constitution. We want there to be some redundancies built into the system so that no single view becomes too dominant.

What say you on the proposal for federal chartering of insurance (page 40)?

[Nick Psaki]

The Constitutional system of checks and balances is based on countervailing power, not redundancies, hierarchies, and bureaucracies. Also, that system is aimed at limiting the power of government, not the power of individuals. Those are two very big philosophical differences. Overlapping jurisdictions sow the seeds of paralysis and inefficiency, bad for government, especially bad for the people caught in the middle of bureaucratic turf wars.

[Russ Walker]

Instead of imposing new regulations upon existing regulations, the common sense approach is to find out what and who caused the "Mortgage Crisis" and subsequent economic meltdown. Root out and eliminate the problem areas and persons involved before rebuilding with fundamental regulations. Are there any people or politicians with the backbone to ask for and carry out this common sense approach?
If this is not done, it will be one of if not the most colossal cover-ups of all time!!!

[Elizabeth Brown]

The white paper is just repackaging the Office of Insurance Information (OII) proposed under the Paulson blue print as Obama's Office of National Insurance (ONI). Unlike the Paulson blue print, the white paper hedges on whether an optional federal charter for insurance should be created by also supporting better state regulation as a substitute for an optional federal charter. The idea of an optional federal charter has been bouncing around the Congress since the Gramm-Leach-Bliley Act of 1999 was passed and which left insurance regulation in the hands of the states. A majority of players in the insurance industry seemed to support an OII/ONI but the industry is divided over whether an optional federal charter is desirable and the states are strongly opposed to it. So like much of the other proposals, the white paper calls for what appears to be politically feasible rather than what would be best to address the existing problems within our regulatory structure or to address the causes of our most recent financial crisis.

One difference between the Paulson blue print and the white paper is that large insurance financial conglomerates that may pose systemic risks would be classified as Tier 1 financial holding companies (Tier 1 FHC) and subject to regulation by the Federal Reserve and the Financial Services Oversight Council. This regulation is not optional. How many insurance financial conglomerates would be classified as Tier 1 FHCs is unclear. Certainly AIG would be classified as a Tier 1 FHC. There are a large number of insurance financial conglomerates that were regulated as thrift holding companies by the OTS or as bank holding companies by the OCC, which potentially could be classified as a Tier 1 FHC. Not all of the insurance financial conglomerates that are regulated as thrift holding companies or bank holding companies have received TARP funds. So it may be that only the ones that received TARP funds would be moved up into the Tier 1 FHC category and subject to regulation by the Federal Reserve and the Financial Services Oversight Council while the remainder would continue to be regulated by the National Bank Supervisor, which will be created out of the merger of OCC and OTS.

[WandaColassi]

I think this shift toward regulation is a good thing that will help bring us out of this economic slump we're in. Something needs to be done fast, house are foreclosing left and right, even marriages are dissolving b/c of this bad economy: http://lawblog.legalmatch.com/2009/06/17/california-divorce-recession-alimony/ .

[Alexw]

wanda, you are an idiot. Please remain quiet while the adults talk.