Treasury Secretary Henry M. Paulson Jr.'s blueprint for regulatory reform, officially unveiled Monday, sets the stage for a confrontation with Congress by offering no relief for troubled homeowners and in many instances advocating less, not more, federal supervision of the nation’s financial system.
Paulson proposed the broadest restructuring of federal regulatory institutions in 75 years with a call to merge agencies and redraw lines of authority that in some cases go back to the Great Depression. But the plan would put off for years any attempt to create new regulations for the streamlined system to enforce.
As a result, even if the new structure were eventually adopted, it would do little to prevent a repeat of the current crisis or something similar, the Treasury secretary acknowledged.
The limits of the administration’s approach drew immediate criticism from Democrats as well as some analysts.
“In a different time, the administration’s proposal would be a welcome start to a needed debate about modernizing the financial services regulatory system,” said Ellen Seidman of the New America Foundation, a centrist think tank in Washington. “But this proposal does not deal with the root causes of our current crisis.”
Paulson said that upheavals have become a regular, if unfortunate, part of the financial system’s operation.
“I am not suggesting that more regulation is the answer, or even that more effective regulation can prevent the periods of financial market stress that seem to occur every five to 10 years,” the Treasury chief said Monday while unveiling the 218-page plan.
House Speaker Nancy Pelosi (D-San Francisco) called Paulson’s plan a “step in the right direction” but said, “We need to go further.”
“We must take steps now to provide help to families who are hurting” because of mortgage foreclosures and job losses, she said in a statement.
Paulson’s proposal reflects both the Bush administration’s aversion to government intervention in the economy and his own experience on Wall Street.
“He’s taking advantage of the current crisis to push a regulatory restructuring plan that would otherwise attract no interest,” said Robert Litan, a senior fellow at the nonpartisan Brookings Institution in Washington.
Paulson, the former chairman and chief executive of investment giant Goldman Sachs Group Inc., described Washington’s regulatory apparatus as utterly outmoded and outflanked by market innovations such as sub-prime mortgages and mortgage-backed securities.
He said that financial innovation was racing ahead at such a feverish pace, the best the federal government could hope to do was define the broad outlines of a system that could be altered as new financial products, opportunities and threats emerged.
“We should and can have a structure that is designed for the world we live in, one that is more flexible, one that can better adapt to change,” he said.
Much of the nation’s regulatory apparatus is now focused on making certain that traditional banks are run safely and soundly.
But bankers have watched their importance diminish in recent decades as financial players such as mortgage brokers, hedge funds, consumer finance companies and others have taken on bigger roles.
The current crisis started last summer, when many sub-prime borrowers -- those with flawed credit histories -- began failing to make their monthly mortgage payments, raising doubts about the value of their mortgages and setting off a rash of foreclosures. Similar doubts then cascaded throughout the financial system.
In his speech, Paulson singled out sub-prime mortgages as an example of an innovation that had benefited society. Among other things, he said, they provided people who had previously been denied credit plentiful financing to buy homes.
But the new loans were outside the normal purview of Washington’s bank regulators, so the mortgages went almost entirely unregulated until they had seeped into nearly every corner of the financial system in the form of mortgage-backed securities.
Paulson’s proposal envisions creating a mortgage origination commission that would include federal bank regulators and state officials. The commission would propose licensing requirements for mortgage brokers and a method for revoking those licenses in cases of bad behavior.
But the commission’s only clout would be the threat of giving states that do not adopt the regulations a bad grade on a regularly issued report card.
“It was regulators’ mindless belief that the market is always right that made them deaf to warnings that the sub-prime market was trouble,” said Barbara Roper, investor protection director for the Consumer Federation of America. “Until you change that attitude and the reluctance to regulate, consumers and investors aren’t going to see any benefit.”
The administration faces a number of larger problems in pushing its plan.
First, the core of the plan was devised more than a year ago to reflect Paulson’s -- and the president’s -- conviction that the U.S. must lighten regulations on its financial industry or risk losing business to foreign financial centers such as London and Hong Kong.
But the proposal is being unveiled after the sub-prime mess, the housing meltdown and sliding financial markets left tens of millions of people poorer and more pessimistic.
It is also subject to the judgment of a Democratic-controlled Congress in no mood to give financial firms more leeway.
“We must restore the trust and confidence of investors and consumers,” Senate Banking Committee Chairman Christopher J. Dodd (D-Conn.) said in a statement. “That trust has been shattered -- not because regulators did too much, but because they did too little.”
Second, the plan has already revived a series of nasty spats among interest groups that scuttled previous bids to restructure financial oversight.
For example, the administration’s call to give insurance companies -- overseen by state regulators for more than a century -- the option of adopting a federal charter and being federally regulated has raised the hackles of state officials.
In many states, including California, officials saw the overhaul plan as treading on their turf and said that, unless changes were made, they would fight it.
“The Bush administration’s colossal expansion of federal powers . . . must not come at the expense of states, many of whom have led the way in strong regulatory financial reforms,” said Ted Lieu (D-Torrance), chairman of the California Assembly’s Banking and Finance Committee. “The Treasury Department’s current proposals will cut us off at the knees.”
Similarly, the administration’s proposal to consolidate the Securities and Exchange Commission, which regulates most stocks, and the Commodity Futures Trading Commission, which regulates complex futures contracts, has provoked pointed objections from the agencies themselves as well as the chairmen of their congressional oversight committees.
Walter Lukken, acting chairman of the Commodity Futures Trading Commission, warned in a statement that combining the two agencies could “jeopardize” the commission’s “market expertise, manageable size, problem-solving culture and global outlook.”
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Here are important elements of Paulson’s plan to restructure federal oversight of financial institutions.
Expand the president’s working group on financial markets to include more federal regulators.
Establish a mortgage origination commission to set licensing standards and assess state compliance.
Give the Federal Reserve the right to inspect non-banks that have temporary direct access to central bank loans.
Set up some form of oversight for state-chartered banks.
Eliminate the Office of Thrift Supervision and give its responsibilities either to the Federal Reserve or the Federal Deposit Insurance Corp.
Set up oversight of payment and settlement systems through the Federal Reserve.
Consider federal oversight of the insurance industry.
Combine the Securities and Exchange Commission with the Commodity Futures Trading Commission.
Create three streamlined regulatory agencies, including:
Market stability regulator, a kind of expanded Federal Reserve with the ability to intervene when it detects a broad threat to the nation’s financial system.
Prudential financial regulator, designed to assure the safety and soundness of any financial institution operating with a federal guarantee, including depository institutions.
Business conduct regulator, designed to protect consumers from unfair or unethical practices.