04/24/2008 09:35:17 AM EST
Rationalizing U.S. Financial Regulation: The Treasury's Plan
Financial and corporate crises bring regulation; the bigger the crisis, the more the regulation. A few years ago, major corporations, particularly Enron and WorldCom, were engulfed in scandals. Coming hard upon the bursting of the dot.com bubble and revelations of improper sales practices of Wall Street banks, these scandals were the catalyst for the Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley"), a far-reaching reform of public companies. One forgets that, only about a year ago all the talk in financial and business circles focused on the need to roll back Sarbanes-Oxley, which was allegedly proving to be too burdensome for U.S. business. Regulation, or at least constraining regulation, tends to disappear only in the good times. As another example of this counter-revolutionary trend, in 1999 the Depression-era restriction on keeping separate commercial banks, investment banks, and insurance companies ended with the passage of the Gramm- Leach-Bliley Act. By contrast, in these dire times the voices for regulatory rollback fall silent and those for regulatory expansion are heard. In keeping with this pattern, the U.S. Treasury Department has just released a plan (the "Treasury Plan") for sweeping reform of financial regulation that is in part necessitated by the financial crisis, which has exposed problems in the regulation. Professor James Fanto explores what may be in store for us.
Mr. Fanto writes: In brief, the Treasury Plan calls for three levels of reforms: short-term, medium-term, and long-term. In the short term, the Plan addresses several immediate symptoms of the crisis (as well as enhances the role of the President’s Working Group on Financial Markets, which advises on financial regulation). It proposes to formalize the current system whereby, on an emergency basis, the Board of Governors of the Federal Reserve System (“Federal Reserve”) makes its loan facilities available to non-banks, in addition to banks. It also proposes, in this short term, to implement a system of uniform qualifications for mortgage originators (to be administered by the states); in other words, it would regulate the party that triggered the current financial crisis. In the medium term, the Treasury Plan is more ambitious: among other things, it proposes to abolish the distinction between a federal savings and loan and a national bank charter, to select one federal “back-up” regulator for state banks (now responsibilities are shared between the Federal Reserve and the Federal Deposit Insurance Corporation (“FDIC”), which administers he insurance program for bank deposits), to make the Federal Reserve in charge of all “systemically-important payment systems,” to provide for an alternative federal insurance charter (now insurance companies are chartered by the individual states) and for a federal insurance regulator, and to combine the Securities and Exchange Commission (“SEC”) and the Commodity Futures Trading Commission (“CFTC”) and to make their collective regulation principles-based.
Finally, and most ambitiously, in the long term the Treasury Plan would revamp the entire financial regulatory system in an “objectives-based” way. It would make the Federal Reserve the regulator of “market stability” (presumably doing what it has done recently to prevent a financial meltdown). It would also create a new “prudential” financial regulator whose job it would be to focus upon the financial stability of individual financial firms, like banks and insurance companies, that receive (or would receive) federal financial guarantees (and are thus partly outside the market) and to deal with such matters as capital adequacy, activities limitations, and risk management in them (here current national bank regulators would be combined). Finally, it would establish a “business conduct” regulator, which would be in charge of consumer protection, firm disclosure, business and sales practices for all firms, and chartering and licensing of financial firms (investment banks, futures commission merchants, investment companies and advisers, hedge funds, etc.) that do not have a government guarantee (the combined SEC/CFTC would fit here).
The Treasury Plan is thus breathtaking. The Treasury Secretary is certainly using the current crisis as an excuse to rationalize a patchwork of financial regulation that has grown by accretions over the years, often in response to financial crises, but that is difficult to justify, even if each part makes individual sense. That is, it may make perfect sense for the SEC, together with the self-regulatory organization, the Financial Industry Regulatory Authority, to regulate broker-dealers, the Office of the Comptroller of the Currency (“OCC”) national banks, the Federal Reserve financial holding companies and state member banks, the Office of Thrift Supervision savings and loans, the CFTC futures commission merchants, to say nothing of the 50 State banking and insurance regulators who also regulate state-chartered financial firms. Each regulator has developed expertise with respect to, and thus oversees knowledgeably, financial institutions within its domain (this is known as functional regulation). However, the regulatory system becomes strained when, as has happened over the past 20 years, these different financial firms both offer overlapping and even similar products and services and are affiliates within large financial holding companies that need to keep track of the collective risks of the subsidiaries and
want all of them collectively to serve a financial group’s clients.