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|President Obama's sweeping proposal to overhaul the financial regulatory landscape is perhaps the most comprehensive and ambitious plan in 76 years -- ever since FDR's New Deal ushered in the Securities and Exchange Commission, among other institutions and rules.
Indeed, if the points and proposals outlined in the president's 88-page draft reform package come to pass, this reshaping of government oversight of the financial system could -- for good or for ill -- become the biggest legacy of the economic crisis, and Obama's presidency.
Whether that legacy is viewed favorably or not, only time will tell. After all, government regulations can have unintended consequences. Whether these changes will make the system more fair and transparent is anyone's guess. You don't have to be a Libertarian to know that government action can just as easily distort markets as make them more efficient.
Some observers remain keenly skeptical of the administration's efforts. Influential bank analyst Richard Bove of Rochedale Securities believes the Obama rules will only add costs to the system and will not lead to more effective oversight. After all, a regulatory framework is already in place, Bove says, but the political will to enforce it has been absent -- and that's just the way Washington wants it. Indeed, the only truly aggressive SEC director since the Kennedy administration was Harvey Pitt, Bove says. "[And] when he got religion about regulation, he got removed."
Dr. Walter Gerasimowicz of New York-based Meditron Asset Management is dubious about a number of proposals, especially that of expanding the Fed's role. “What I find to be very disconcerting is the fact that our Federal Reserve is going to have extensive power over much of the industry," Gerasimowicz says."Why would we give the Fed such powers, especially when they’ve failed over the past 10 years to monitor, to warn, or to bring these types of speculative bubbles under control?”
From eliminating the Office of Thrift Supervision to regulating hedge funds, the new rules would give the government greater power over Wall Street. And as for Main Street, the administration proposes creating a new agency to protect consumers when it comes to mortgages, credit cards and other consumer financial products.
If all this comes to fruition, there'll be a new sheriff (or sheriffs) in town. Here's a look at what some of the proposed changes could mean for consumers and investors. (But don’t expect change any time soon. Congress will wrestle with health-care reform first and then move onto these new initiatives in the fall.)
Foreclosing on the OTS
The Obama plan seeks to shut down the Office of Thrift Supervision and replace it with a new national regulator. "The view now is that you can't let the system function on its own and that it needs some guidance and oversight," Bove says.
The OTS, after all, is an easy target. The agency provides national oversight of the thrift industry. Historically, a thrift was a fairly simple business: Take in deposits and make loans, especially mortgage loans. Alas, times and financial innovations change -- and given the rash of bank failures, it's not hard to claim that the OTS was not up to the job.
As banks grew into so-called financial supermarkets, the lines of regulatory oversight become cloudy -- and the OTS wasn't necessarily designed for many of the roles it had to assume. Obama's proposed new national regulator would make it more difficult for companies to pick and choose among regulators -- or even slip through the regulatory cracks. If the new regulator can prevent things like the collapse of Washington Mutual -- once the nation's largest thrift -- then the system and consumer would be better served.
More Capital Reserves … but Less Stability?
The requirement that banks and other financial institutions set aside more capital could actually have mixed consequences. Not only could "perceived" stability fall short of the goal of actual stability by not creating large enough reserves, but the greater reserves could also be sizable enough to hamper growth. After all, banks profit by lending out money and charging interest.
"There's a desire to continue to increase the capital base of the banking system, which is going to substantially reduce the amount of funds a bank can make available," Rochdale's Bove says. "But [Obama] wants to regulate all kinds of other industries [besides banks], and that drives up the cost of everything. If you need to set aside more capital, it drives up the cost of financing and it takes money out of the system, and we need that money to produce goods."
The checks on securitization are another byproduct of the reformist urge. The mortgage securitization pools that triggered the subprime mortgage crisis were perfectly legal, but their creation was a rational response to an overheated market. "We export $1 billion a day to pay for imports of other countries' goods," Bove says. "Those pools form huge amounts, and that money has to go somewhere. It starts chasing a return, and they had to keep changing underwriting standards. The rational response of people who saw it coming was to create a product that got that investment."
Hedging in the Hedge Funds
Hedge fund registration, another plank of the Obama reform package, won't succeed if it tries to do too much, cautions Joel Schwab, managing director at Channel Capital Group, a consulting and services firm for the hedge fund industry. "It looks pretty clear there will be a hedge fund regulation plan," he says. "What's important is that it achieves its goals. If your goal is to find every Bernie Madoff situation, then you'd have to register every hedge fund – we won't find every Ponzi scam unless there are enough expertly trained personnel out there, and right now we don't have that."
The argument that these unregulated pools of capital pose a systemic risk to the financial system has its limits, since no hedge fund since Long-Term Capital Management, which collapsed in 1998, has truly posed a systemic threat to the market even if it blew up and lost money for its investors.
"You can make a pretty good case that there's a size of hedge fund where the government should have access -- on a confidential basis," Schwab says. "But I think it's unlikely that right now a hedge fund exists that has exposure that could systemically threaten the market."
Mortgage Makeover … or Just More Risk?
The proposed new Consumer Financial Protection Agency would have the authority to regulate mortgages. One proposal is to require all lenders to offer borrowers standard, fixed-rate mortgages, potentially requiring anyone taking out a riskier adjustable-rate mortgage to sign a waiver.
Eventually the new agency could produce more clarity on regulations, but while lenders wait to see what the new rules will be, they may hesitate to lend, says Keith Gumbinger, vice president of HSH Associates, a company that collects information on mortgages and consumer loans. “When you have an ill-defined market, you have injected an element of risk you didn’t have before,” Gumbinger explains.
If regulations do work to discourage adjustable-rate mortgages, “some percentage of borrowers will miss an opportunity, or delay an opportunity for home ownership,” he says.
A Reeducation for Student Loans
The new Consumer Financial Protection Agency would have the authority to regulate student loans as well as other financial products.
“I don’t see this as having an immediate impact on student loans, in part because there have been a lot of improvements in consumer protection for student loans in recent years,” says Mark Kantrowitz of Finaid.org, a web site that provides information about financial aid and loans.
Creating an independent agency could, however, reduce any potential conflicts of interest on the part of regulators. Under the old rules, regulators were often trying to protect consumers while also looking out for the overall financial health of the industry they oversee. “This new Consumer Financial Protection Agency would have only one charge: protecting the financial interests of consumers,” Kantrowitz says.
Credit Cards -- Untangling a Complicated Web
Sorting through the tangle of the complex credit-card industry would be a huge task for the new Consumer Financial Protection Agency.
“I’m not generally for big government,” says Curtis Arnold of Cardratings.com, which helps educate consumers about credit cards. “But I think in this case it makes some sense” to create a new agency that could tackle the problem of credit cards. But Arnold feels that regulation alone isn’t enough.
“Granted, the card industry needs to be reined in, but I think they’re missing the second part of the equation, and that’s consumer education,” Arnold says. “Reading the fine print, understanding the credit-card terms, is your protection as a consumer.”
One point the new regulations didn’t tackle: credit card interest rates. Reports say the new rules don’t cap how much interest card companies can charge.
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