Saturday, June 20, 2009

Mountain crisis, mouse reform

Business Times - 20 Jun 2009

Mountain crisis, mouse reform

The financial restructuring plan unveiled by Obama is high on rhetoric but low on solid proposals to prevent future catastrophes in the financial system


DURING the height of the current financial crisis, at a time when the perception on Wall Street and in Washington had been that the sky was falling and that, at a minimum, the American economy and the entire capitalist system were about to collapse, the hope among progressive Democratic lawmakers and activists - and the fear among bankers and hedge fund investors - was that newly elected President Barack Obama would lead a crusade to change the way business was done on Wall Street.

After all, it was Mr Obama who had warned during the election campaign last October that Americans were 'living beyond their means, from Wall Street to Washington to even some on Main Street'.

In fact, pundits speculated that after the falling of financial giants like Lehman Brothers and American International Group (AIG) and the recognition that the failure of such entities that were described as 'too big to fail', Washington would resist the political pressure from lobbyists representing Big Money in Washington and would take steps towards a sweeping restructuring of the financial industry.

At the end of the day, the banks, the insurance companies and other financial institutions would become smaller, more manageable and more responsive to Washington's regulators. In fact, doing business on Wall Street would once again be the kind of mind-numbing and dull career that it used to be before the deregulation boom in the 1980s and the 1990s, and would cease to attract America's best and brightest.

When President Obama laid out in Washington on Wednesday his 89-page plan to overhaul this country's financial markets and reshape the federal system of financial regulation - which was described by administration officials as the biggest overhaul of its kind in decades - his rhetoric still reflected those earlier expectations.

'It is an indisputable fact that one of the most significant contributors to our economic downturn was an unravelling of major financial institutions and the lack of adequate regulatory structures to prevent abuse and excess,' Mr Obama stated.

'A culture of irresponsibility took root from Wall Street to Washington to Main Street. And a regulatory regime basically crafted in the wake of a 20th century economic crisis - the Great Depression - was overwhelmed by the speed, scope and sophistication of a 21st century global economy,' he said.

But the much anticipated Obama plan whose outlines were drawn up by Treasury Secretary Tim Geithner and National Economic Council director Lawrence Summers stopped short of the sweeping changes of the way business is done in Washington and Wall Street.

In particular, the plan refrains from taking comprehensive steps to reorganise the existing regulatory agencies and to create a new and powerful super-regulator.

President Obama stressed that he made that decision to maintain a 'careful balance' in regulating the financial industry after consulting congressional leaders, industry experts and consumer advocates.

'I believe that our role is not to disparage wealth, but to expand its reach; not to stifle the market, but to strengthen its ability to unleash the creativity and innovation that still makes this nation the envy of the world,' Mr Obama stressed.

'So that's our goal: to restore markets in which we reward hard work and responsibility and innovation, not recklessness and greed, in which honest, vigorous competition in the system is prized, and those who game the system are thwarted.'

According to Mr Obama's proposals, the Federal Reserve Board would supervise financial firms considered 'too big to fail', while a new 'council of regulators' led by the Treasury Department would monitor risk across the financial system.

At the same time, the Securities and Exchange Commission (SEC) would demand greater disclosure by hedge funds and regulate exotic financial instruments such as credit default swaps. And the administration is also calling for a new agency to protect consumers, the Consumer Finance Protection Agency.

Some on Wall Street have been critical of the president's plan and, in particular, the call for more government involvement in the financial industry, and a legion of lobbyists is now camping on Capitol Hill, where Congress will start debating Mr Obama's proposals in the coming weeks.

The Congressional hearings will be led by two leading Democratic leaders, Representative Barney Frank of Massachusetts and Senator Christopher Dodd of Connecticut, who promised that legislation along the lines of Mr Obama's proposals would be enacted before Congress adjourns for the year.

But there were many smiling faces on Wall Street after President Obama presented his plan on Wednesday. The heads of the financial industry are content that the Fed will be responsible for regulating their business - which explains why the more populist critics on the political left and right are unhappy.

The US central bank and its leaders are perceived as allies of Wall Street in Washington who lack both the political will and technical expertise to regulate the large financial companies, as has been demonstrated before and during the current crisis when the Fed seemed to fail in its efforts to contain the problems that were facing such institutions as Wachovia, Citigroup and Bank of America.

It's also unclear what kind of power the proposed council of regulators will have in terms of affecting the decisions made by the Fed.

'We have resisted creating an all-powerful central bank to this point, and the experiences of countries which have concentrated too much power in one entity serve as cautionary tales,' said Mark Warner, a Democratic senator from Virginia who sits on the banking committee, who wants to give more regulatory power to the council of regulators.

'A systemic risk council is not a silver bullet, but it avoids the pitfalls of entrusting systemic risk responsibility to one agency,' he said.

The main question on the minds of US lawmakers and other observers will be the following: will the reformed regulatory structure headed by the Fed be able to monitor those institutions that are 'too big to fail' and prevent the series of catastrophes that have devastated the financial industry in the last two years?

In short, will the Fed have the necessary resources and power to detect the kind of problems that had confronted Lehman Brothers and AIG before Washington is faced with only two choices - either let these financial institutions fail or force the American taxpayer to bail them out?

We shall see if the words in the final legislation match the rhetoric.

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