"A thin outline of regulatory reform
Published: June 21 2009 18:43 | Last updated: June 21 2009 18:43
The Obama administration’s proposals for US financial regulation are pretty good, as far as they go. The problem is they do not go far enough.
Great care and intelligence went into the plan announced last week. It makes no stupid suggestions; recall Sarbanes-Oxley, a recent instance of unguided regulatory backlash, and you see this is no small achievement. But the plan’s comprehensiveness is a bit of an illusion. It ignores many issues, and has more loose ends and suggestions for further review than actual innovations.
Also, as in other areas, the White House is unwilling to confront the political barriers to fuller reform. You can call this pragmatism, or you can call it timidity. A crisis of this order demands big new ideas, and the leadership to push them through. In finance, if not now, when?
The administration asks Congress, which will have to write new laws for the plan to work, to fill some of the biggest holes in the existing structure. Systemically important financial institutions, whether or not they are banks in the old-fashioned sense, should be more tightly regulated by the Federal Reserve, says Mr Obama.
In addition, a new intervention regime should cover all such firms, modelled on the scheme run by the Federal Deposit Insurance Corporation for ordinary banks, says the plan. The idea is to wind up a failing bank early and in an orderly way, rather than facing the choice of bailing it out or letting it collapse and maybe drag others down with it.
The administration is right: these are big and necessary changes. But the details are vague. How exactly the tighter regulation of these “tier one financial holding companies” will work – what their capital and liquidity requirements will be, for instance – is for further study. Firms in this category will pay a regulatory surcharge, as they should. And the plan seems to favour counter-cyclical capital requirements too, which would brake lending growth in credit booms. Again this is right; again there are no specific proposals.
The plan calls for tighter regulation of securities markets. It proposes, for instance, that issuers of credit-risk securities should retain a share of the risk. It wants many over-the-counter derivatives to be traded on exchanges, which is safer, and proposes to bring “all OTC derivatives and asset-backed securities into a coherent and co-ordinated regulatory framework”. Quite right.
But what about Fannie Mae and Freddie Mac, the vast “government sponsored enterprises” that were instrumental in stoking the subprime boom? The plan bravely calls for a “wide-ranging initiative to develop recommendations”.
What about the credit-rating agencies, and the measurement of risk for regulatory purposes more generally? There is no point in telling financial institutions to set aside more capital if they are free to pump up their risks at the same time. The plan is thin. It wants better regulation of the rating agencies. Who doesn’t? But what would better regulation of the agencies look like? That needs further study.
“The financial crisis highlighted the problems associated with compensation structures that do not take into consideration risk and firms’ goals over the longer term,” says the plan. Indeed it did. The report says little on what to do about it, and next to nothing about wider bank corporate governance.
Fair-value accounting? Further review.
These are all complicated issues, and wide consultation is doubtless required to design the rules. So in a way it is unfair to complain about loose ends. It would be easier to feel that way if the administration had got things right at the organisational level. Unfortunately it has not. Perhaps the biggest disappointment in the plan is that it fails to address the bewildering complexity of the regulatory apparatus.
Unlikely as it may seem, the plan suggests a net increase in regulatory agencies. In the US, this requires real ingenuity. Recognising the issue of “jurisdictional disputes among regulators” – a problem that is going to get worse under these plans – it calls for a new Financial Services Oversight Council, chaired by the Treasury. This would advise the Fed on which firms should be regarded as systemically significant, and “facilitate information sharing and co-ordination”. Regulation by committee, atop a system of overlapping agencies unsure of their responsibilities, with financial firms still free to shop around for a regulator they like, does not inspire.
Crucially, it also militates against effective international co-ordination. Aside from poor oversight of the shadow banking system and the system-wide failure to account properly for risk, the biggest weakness in the existing regulatory scheme has been lack of cross-border co-operation by national regulators. The more complicated the domestic regulatory structure, the harder it will be for US regulators to work with their counterparts abroad.
Why no effort to streamline the structure? The answer seems to be that Congress would object. A simpler organisation chart would strip its oversight committees of responsibility, and their members of influence. The White House apparently regards this as too much to ask. On health reform, the administration has given control of the entire project to Congress. On financial regulation, it is still trying to direct the policy – but from the outset within limits that respect the legislature’s preferences, however ill advised. That is a pity.