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What is Obama financial reforms: Remaking Financial Regulation; hopes to avert future crises?

By Amarendra Bhushan for CEOWORLD Magazine Updated:June 15, 2009

President Barack Obama is expected to propose a rules and systems sweeping reorganization of financial-market supervision, including remaking the powers of the Federal Reserve.

The goal is to prevent a recurrence of the economic crisis that erupted in the United States and exploded around the world. They could result in a major realignment of power and authority among government agencies that set the rules for banking, lending and investing and daily transactions, from credit cards to mortgages and mutual funds.

The Wall Street Journal reports that “President Barack Obama is expected Wednesday to propose the most sweeping reorganization of financial-market supervision since the 1930s.” It is not at all clear that the rules and regulation of the Great Depression era did anything to improve the financial system. Separating banks and brokerages may have undercut the ability of financiers to blend money that should be safe with money that should shoulder risk. The FDIC may have helped depositors whose savings where at risk due to bank closings.

What regulation failed to due was prevent financial institutions from doing what they are meant to do which is make money. The observation may seem facetious, but the ability to create new capital is based on the ability to take intelligent risk. The one thing no set of rules can do is undercut stupidity and eliminate greed. Both seep back into the system like water through cracks in a wall.

In devising new regulations and oversight, the administration is looking to address four perceived weaknesses in the current system:

The lack of an all-seeing federal entity to detect institutional stresses that threaten the financial system, and the government’s inability to step in and unwind large institutions before they choke the system. The Federal Deposit Insurance Corp. can do this with banks, but the government lacked the power to do the same with a behemoth such as the insurer American International Group.

The undercapitalization of large financial institutions. Heading into the financial crisis, too many banks were leveraged with significantly more debt than equity. “If you give people enough leverage, they can lose an unbelievably large amount of their own money and that of their clients,” Obama’s chief economic adviser, Lawrence Summers, said last week.

The emergence of large, lightly regulated markets, such as hedge funds, and of big insurers, such as AIG, without a federal overseer. The administration wants large private investment funds to register with the Securities and Exchange Commission and is weighing the creation of a federal charter for insurance firms.

Consumers and lenders whose unwitting or reckless credit and borrowing decisions placed families under staggering debts and contributed to the instability of the financial system. Obama is likely to recommend creating a financial services consumer protection body with oversight powers over mortgages and credit cards and other consumer financial products.

Lawmakers are expected to take issue with several areas of the plan, including how to create a system that won’t simply bail out large financial companies when they topple. Giving the Fed more clout also will be a controversial idea, the Journal notes.

Treasury Secretary Timothy Geithner and National Economic Council Chairman Lawrence Summers said in their op-ed that the Obama Administration would put forward a plan this week focusing on five key regulatory points:

“Raising capital and liquidity requirements for all institutions, with more stringent requirements for the largest and most interconnected firms.” In addition, the officials said, “all large, interconnected firms whose failure could threaten the stability of the system will be subject to consolidated supervision by the Federal Reserve, and we will establish a council of regulators with broader coordinating responsibility across the financial system.”

Regulation of derivatives markets that will involve “robust reporting requirements on the issuers of asset-backed securities; reduce investors’ and regulators’ reliance on credit-rating agencies; and… require the originator, sponsor or broker of a securitization to retain a financial interest in its performance.” The op-ed said “all derivatives contracts will be subject to regulation, all derivatives dealers subject to supervision, and regulators will be empowered to enforce rules against manipulation and abuse.”

Construction of “a stronger framework for consumer and investor protection across the board.”

Creation of a “resolution mechanism that allows for the orderly resolution of any financial holding company whose failure might threaten the stability of the financial system.” They added,” this authority will be available only in extraordinary circumstances, but it will help ensure that the government is no longer forced to choose between bailouts and financial collapse.”

“ We will lead the effort to improve regulation and supervision around the world,” the officials said. “We live in a globalized world, and the actions we take here at home — no matter how smart and sound — will have little effect if we fail to raise international standards along with our own.”

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