Top advisers preview government’s regulatory reform proposals

President Obama’s top two economic advisers confirmed what has been systematically leaked in recent weeks – the administration won’t propose any radical structural changes in the U.S. financial regulatory system. 

Treasury Secretary Timothy Geithner and White House economic adviser Larry Summers avoided any adjectives like “sweeping” or “radical” in previewing their plan for regulatory reform in an op-ed for the Washington Post.

The two men noted that the current system, which failed to stop the worst financial crisis since the Great Depression, is “riddled with gaps, weaknesses and jurisdictional overlaps, and suffers from an outdated conception of financial risk.” 

But they modestly propose to “put forward a plan to modernize financial regulation and supervision” that will “create a more stable regulatory regime that is flexible and effective.” 

The actual plan is to be made public on Wednesday in the form of a “white paper” that will provide a road map to Congress for legislation. 

The op-ed affirms the two core proposals enunciated for the past few months by administration officials – a mandate for the Federal Reserve to monitor systemically important institutions for risks that could affect the entire financial system and authority for the government to seize and unwind non-bank financial companies when their failure would destabilize the whole system. 

However, there is no mention of amalgamating the various bank regulators or merging the two financial markets regulators, the Securities and Exchange Commission and the Commodity Futures Trading Commission. 

Rather, Geithner and Summers say that capital and liquidity requirements for all financial institutions will be raised. Gaps that appeared in the “shadow” banking market of securitization will be filled by “robust” reporting requirements for originators of securitized products and by requiring originators, sponsors and brokers to retain some financial interest in the new security. In addition, there will be measures to reduce investors’ and regulators’ reliance on credit rating agencies. 

The op-ed piece does not specifically mention creation of a new Financial Products Safety Commission. Instead, the two policy makers have this to say: “Building on the recent measures taken to fight predatory lending and unfair practices in the credit card industry, the administration will offer a stronger framework for consumer and investor protection across the board.” 

However, a report in The Wall Street Journal citing unnamed “administration officials” says the plan will include a new regulator for financial products that will take over supervision of credit cards and mortgages from the Fed but will not remove mutual funds from SEC supervision. 

Geithner and Summers do mention that a “council of regulators” will also oversee systemic risk but they don’t detail how this will mesh with the Fed’s new authority. 

Instead of a merger between the SEC and CFTC, the op-ed speaks of “harmonizing the regulation of futures and securities.” In addition, the proposals will include “more robust safeguards” for payment and settlement systems and, echoing the recent testimony by CFTC chairman Gary Gensler, “strong oversight” of over-the-counter derivatives. 

The Wall Street Journal also mentions that hedge funds will be required to register with the government, and that large funds may face federal supervision. 

There is no discussion in the op-ed or the Journal piece about added regulation for insurance. 

With the exception of a possible transfer of credit card and mortgage oversight from the Fed to a new body, no agency appears set to lose any significant authority and some will have added duties. It is not readily apparent how the plan will eliminate jurisdictional overlap. 

The op-ed authors stress that now is the time to act, rather than waiting until the financial crisis is completely over, in order to restore confidence in the market that steps will be taken to avoid a similar meltdown in the future.