The Obama administration’s broad plan to overhaul financial regulations offers dozens of new ideas about how to keep the markets safe, maintain a sound banking system and protect consumers and investors.
But the 88-page plan now faces the same scrutiny, backlash and political infighting that has hampered reforms of the financial system since the earliest signs that a decade of deregulation went too far.
Initial efforts to consolidate the sprawling system of dozens of financial regulators fell short. Instead, the Obama administration has opted for the more politically expedient course of updating the rules and responsibilities for existing agencies already charged with maintaining the safety and soundness of the markets and banking industry.
“As the debate played out, they realized it would be near impossible to get wide, sweeping reform enacted,” said former SEC Commissioner Laura Unger. “I think they wisely chose the safer path.”
That leaves the existing patchwork of regulators — and the potential for gaps and loopholes — largely intact. Banks will still be regulated by, among others, the Federal Reserve, the Federal Deposit Insurance Corp., the Office of the Controller of the Currency, the National Credit Union Administration and 50 separate state banking regulators. (The Office of Thrift Supervision will be eliminated and its functions folded into other bank regulators.)
Financial markets will continue to be regulated by the Securities Exchange Commission, the Commodities Futures Trading Commission, the Treasury and the so-called “self-regulatory organizations” of the major stock exchanges. Each of these players has fiercely defended its turf in the discussions leading up to Wednesday's proposal.
One of the major changes in the new regulations is a sharper focus on protecting consumers and investors. To that end, the Obama administration wants to create new agency with the single mission of protecting consumers. Supporters of the idea say that the job is very different than the mandate to protect the safety and soundness of banks and financial markets.
“You can’t go back to the regulatory agencies that didn’t act because we know that doesn’t work and didn’t work,” said John Taylor, president of the National Community Reinvestment Coalition, who worked with the administration in drafting the new rules. “We need an independent agency whose mission is this and only this, who are really worrying about whether the consumer, the taxpayer is being tricked, cajoled, cheated, hoodwinked and is being treated fairly enough."
The new consumer sheriff could bring dramatic changes to the way the financial services industry deals with its retail customers. But it remains to be seen how much support Congress will give this new regulator when it tries to overrule the well-funded lobbies that have blocked tougher measures to protect consumers.
The idea of a separate consumer protection agency has already drawn opposition from the Financial Services Roundtable, an industry lobbying group.
Recent legislation to provide mortgage relief and put restrictions on credit card lenders, for example, have produced mixed results.
“I think there will be some debate as to whether (consumer protection) should be embedded within the agencies that oversee these organizations or whether there should be a totally separate entity that could, in fact, stifle innovation,” said Sen. Bob Corker, R-Tenn., a member of the Senate Banking Committee.
There’s little debate that regulatory failures played a critical role in the collapse of the housing bubble and the global financial system. Mortgages were written for buyers with no proof of income, backed by fraudulent appraisals. They were packaged by Wall Street firms that paid agencies for AAA safety ratings based on promises that investors would be protected by trillions of dollars of unregulated risk insurance called credit default swaps.
Banks were allowed to cut their reserves against loan losses to razor-thin margins. Consumer protections against predatory lending weren’t beefed up until 2008, after the market had already collapsed and foreclosures had begun to soar. Despite multiple warnings, regulators at the SEC failed to take action against rogue fund manager Bernard Madoff before he cut a multibillion-dollar path of destruction through the accounts of thousands of investors.
But defenders of financial deregulation maintain that an overreaction to those excesses could do more harm than good by hampering the recovery of an industry that is reeling from its worst contraction since the Great Depression.
"I think (the proposed regulations are) just going to be too big of a foot on an industry that already is having financial problems," House Minority Leader John Boehner told ABC's "Good Morning America" Wednesday.
Some of Obama’s proposals enjoy widespread support and are already under way. Banks have already raised over $100 billion in fresh capital; the new rules would make permanent requirements for a bigger capital cushion.
A more controversial proposal would expand regulation to financial institutions and products not currently covered by banking and market regulations. The rapid expansion of the so-called “shadow” banking system — where risky mortgages and other loans were pooled, chopped into pieces and sold off with AAA safety ratings to investors — lay at the heart of the financial collapse. Proposed new regulations would govern that market, including a rule that bankers would have to share the risk of these products by holding a percentage of these assets on their books.
The new rules also would apply to products like financial derivatives and companies like hedge funds that aren’t currently regulated. One of the biggest road blocks regulators faced when they tried to stem the Panic of 2008 was the lack of basic information about how much risky paper was clogging up the financial system and who was holding it.
The plan also gives the government broader powers to step in and take over a bank or other financial firm that is endangering the broader financial system by taking on too much risk.
Even if enacted in full, the new package of regulations may have only limited impact on the effort to repair the damage done by the collapse of the financial system. The banking system and financial markets are global entities, and regulators in Washington have limited reach beyond the U.S. borders.
The new effort to overhaul financial regulations is also an acknowledgement that existing rules became outdated by rapid innovation on Wall Street, which created risks that were not fully understood even by the creators of some financial products. If history is any guide, the pace of innovation will continue to move more quickly than the regulatory process.
Finally, while changes in the financial markets have created the need for updated regulations, some critics of the process argue that existing regulations simply weren’t applied forcefully enough. Just changing the rulebook won’t ensure that regulatory agencies remain vigilant in heading off the next crisis.
“The bottom line is the regulators failed; it wasn't the regulation,” said Dean Baker, co-director of the Center for Economic and Policy Research. “We could have had better regulation, should have had better regulation. But the regulators failed, and I would say if we want to prevent the next bubble, we have to hold the people accountable for this bubble. So fire them.”