On June 17, the Obama administration will make public its long-awaited white paper on financial reform, quite possibly with a speech by the president himself. Leaks from various players within the administration over the past few weeks have focused on whether there should be a major consolidation of the different agencies that supervise banks, investment companies, and financial exchanges.
But where regulatory oversight is located, which got headline treatment in recent leaks to the Wall Street Journal, is really a minor detail. The more important issue is how tough regulation will be. When I spoke with senior administration economic officials late last week, it was clear that they are still working in the particulars.
Among the most contentious issues will be these:
How should the shadow banking system, namely hedge funds and private equity firms, be regulated?
President Barack Obama has long argued that any financial firm with the capacity to create credit and risk should be subject to regulation; hedge funds and private-equity companies currently are not. But should this include detailed disclosures of trading positions and capital reserve requirements, of the kind required of other financial companies? And who should regulate them? The advocates of tough reform want to have the Securities and Exchange Commission to do the job; allies of the industry want to give general authority to the Federal Reserve, in a new capacity as "systemic risk regulator" but without explicit standards.
Should the Fed get more power -- or less? Treasury Secretary Timothy Geithner is passionate about the idea that the system needs a super-regulator to oversee systemic risk and that this body should be the Federal Reserve. The premise is that since the responsibility of intervening in a crisis falls to the Fed, the Fed should be charged with heading off financial meltdowns before they occur. However, many in the administration and in Congress think this would give the Fed too much power and that the Fed is the wrong agency for the job. Federal Deposit Insurance Corporation Chair Sheila Bair wants a new panel made up of chairs of agencies, with its own professional staff, to be the watchdog for systemic risk; both Rep. Barney Frank and Sen. Christopher Dodd have indicated that they prefer this approach, which has the support of some consumer and industry groups. (See my recent Prospect piece on the Fed and its critics.)
Should there be a Financial Product Safety Commission? Elizabeth Warren, the Harvard law professor who also chairs the congressional oversight panel on the banking bailout program, has long advocated for a commission that would review and restrict potentially hazardous financial products such as sub-prime mortgages, deceptively priced payday loans, and other consumer rip-offs. The argument is that the banking agencies have paid too little attention to consumer welfare and that consumers need an agency that is their champion. The counterargument is that a new Financial Product Safety Commission would scramble lines of authority and that it's better to strengthen bank regulators' ability to safeguard consumer interests just as they assure bank soundness. Support for an FPSC is gaining strength in Congress. My sources say that President Obama was very pleased with the positive reception when he signed the credit-card bill last month and that he is inclined to support more high-profile, pro-consumer measures such as the FPSC but that his senior economic advisers are lukewarm on such steps.
What kind of Resolution Authority for Failed Banks? Since the financial crisis began, the Treasury and the Fed have helped zombie banks like Citigroup with low interest rates, credit advances, and direct infusions of government capital. The idea of a temporary government takeover has been disparaged as "nationalization." Now, in the new administration proposal, Geithner wants government to have the authority to take over failed banks. The FDIC already has that authority for small and medium-sized banks but not for large bank-holding companies. There are two key issues here. Would the new authority go to an expanded FDIC, whose independent-minded chair, Sheila Bair, is sometimes depicted as disloyal to the administration? And would the administration actually use the new authority -- or just keep doling out money to keep sinking banks afloat?
How to Regulate Derivatives? Along with sub-prime mortgages, complex and highly speculative derivative securities, such as credit-default swaps, were at the heart of the financial collapse. Several key Democratic senators were appalled when President Obama named Gary Gensler to chair the Commodity Futures Trading Commission (CFTC), since Gensler, as a Treasury official under President Bill Clinton, was one of the key players in the effort to prohibit CFTC from regulating customized derivatives, such as the ones abused by Enron and American International Group.
Sen. Maria Cantwell of Washington state, one of the Senate's experts on derivatives, put a hold on the Gensler nomination until she got a written commitment from the administration to require much greater disclosure to the CFTC of derivative trading positions as well as capital reserve requirements, but there are potential loopholes. The administration does not yet support the reformers' goal of requiring that all derivatives, including customized ones, be traded on regulated exchanges.
The president's release of a plan next week is only the opening gun. The key House and Senate committees will hold hearings this month, and floor action will not begin until after Labor Day. Senate Majority Leader Harry Reid has said that given all of the other legislative business, he can't imagine the Senate actually passing legislation until early 2010. That's probably a good thing, since it will give consumer groups pushing for tough financial regulation more time to organize, while the continuing weakness of the banking sector provides the exclamation point. Until now, the main players in this insiders' debate have been the government and the financial industry. A new consumer-labor reform coalition made up of several dozen groups is set to be unveiled on June 16, just before the release of the administration's plan.