Is Obama Flubbing the Financial Fix?
The Administration's backtracking on regulatory reform has some critics saying that a rare opportunity is being squandered
By Jane Sasseen
Old habits die hard—especially bad ones, and especially when they're backed by well-heeled lobbyists and a powerful congressional committee chairman.
It was hard not to draw that conclusion over the past week, as Wall Street and Washington alike prepared for President Barack Obama's much-anticipated June 17 speech outlining the Administration's proposals to overhaul financial regulations. Despite the promise of tough reforms from the President and his top economic officials, the Administration—in its decision to put off tough political battles over regulatory turf and reining in executive pay—appeared to be backing away from the stiffest moves that were on the table.
With the worst of the crisis appearing to recede, the political will to take on those tough constituencies appeared to be fading as well. With it may go a once-in-a-generation opportunity to aggressively tackle some badly needed changes in the U.S. financial system.
"Is the drive for reform losing steam? Yes, absolutely," says Daniel Clifton, a Washington-based policy analyst at institutional broker Strategas Research Partners. With Congress signaling that it is unlikely to act on the President's financial-system reforms until the fall, Clifton and other observers warn that this week's regulatory plan could be highly vulnerable to attack for five months. Short of an unexpectedly sharp return of crisis in the financial sector, which would force the Administration and Congress to conclude that the costs of retaining much of the status quo intact are too high, Clifton believes the push for reform "will lose a lot more momentum by October."
The aim of the Administration's regulatory plan, largely developed by Treasury Secretary Timothy Geithner, is to create a more effective and powerful regulatory structure that would have a better chance of preventing the sort of unseen and out-of-control financial excesses that brought about the current global crisis.
needed: a systemic risk regulator
Much of the debate has focused on the need to create one overarching regulator with the broad authority to prevent the buildup of systemwide risk. The lack of such a "systemic risk regulator" made it harder for the Treasury, the Federal Reserve, and other banking regulators to foresee the crisis and take steps to prevent it. And regulators from Geithner on down have also argued that it made things far more difficult for them to react quickly and effectively when the credit system seized up.
Just as important, debate has also centered on how best to modernize the overlapping, often ineffective regulatory structure that now oversees the financial sector. Today, for example, four different—and often competing—regulators oversee the banking sector. Yet despite (or perhaps because of) this surplus of agencies, all failed in varying degrees to prevent the excessive risk-taking and poor practices that led to the crisis. Moreover, the sense that some agencies were easier than others on their charges allowed some financial institutions to engage in "regulatory arbitrage" in search of the overseer that interfered least in their operations.
That's why a wide range of analysts and policymakers in recent months have argued that this hodgepodge of different agencies needs to be consolidated, with clearer lines of authority and stronger regulatory rules. And, in a series of leaks and trial balloons that have hit the headlines in recent weeks, the Administration appears to have considered such a wide-ranging consolidation. But the White House apparently has tabled that consolidation for now—and the reasons for that reassessment are ominous for the prospects of attaining effective reform.
Not surprisingly, such plans sparked strong behind-the-scenes opposition from many in the financial-services industry who want to hold off radical change. Despite the industry's weakened position, it remains an enormous fund-raising source and still holds enormous sway with many on Capitol Hill. Plus, consolidating the regulatory structure would also mean reallocating the authority of the various congressional oversight committees. It may make little sense in the modern financial world for the Commodities Futures Trade Commission to continue to regulate financial derivatives, along with the agricultural derivatives—pork bellies, corn futures and the like—that it was originally mandated to oversee. But giving up sway over those financial products would also mean a big cutback in the power, influence, and fund-raising prospects of the agricultural committees that oversee them in the House and Senate.
congress rushes to shield power and pork
No sooner did reports emerge that the Administration was considering such a move than powerful congressional voices such as Barney Frank, head of the House Financial Services Committee, threw cold water on the idea. "If S&L wasn't enough to radically overhaul how we regulate banks, this won't be, either," says Jaret Seiberg, a financial-services policy analyst at Washington Research Group, referring to the 1980s savings-and-loan crisis. "There are entrenched political interests in favor of the status quo; they have no interest in radical reform."
As a result, the Administration now seems to be backing away from its original reform plans. Instead, it will likely ask the Fed to take on the powerful new role of systemic risk regulator, while leaving most of the various other agencies intact. Rather than eliminating the regulatory redundancies and strengthening the survivors, Geithner plans to rely on implementing stiffer rules to improve how the regulators oversee their charges.
The question, of course, is whether that will be enough. Many are far from convinced. Simon Johnson, a former chief economist at the International Monetary Fund who has been sharply critical of the Administration's approach to the banking crisis, argues in a recent post on his widely read blog that the planned reforms are far too timid. "The wave of 'reforms' this fall will likely not solve anything," he says. Instead, Johnson argues, the U.S. is simply at the beginning of what could be a 5- to 10-year fight to change the structure of economic and political power of the financial sector in the U.S. to ensure that "it can never again run us into a crisis that results in doubling the national debt."
Greg Valliere, chief Washington policy strategist at independent equity researcher Soleil Securities, thinks the systemic risk regulator may be more aggressive than many in the financial sector are expecting. But he, too, believes the Administration is throwing away a broader chance for reform. "I do think it's a missed opportunity if we continue to have the whole alphabet soup of agencies," Valliere says.
once bogged down, it's tough to un-bog
Does the Administration's apparent pullback represent capitulation to powerful forces that oppose change, or is it simply a smart political tactic that will allow the Administration to achieve many of its goals now and come back for more later when they might be more politically achievable?
"The congressional reaction has to play into their decision-making. Obama is not king; he's the President," says Clifton. Add too many devisive elements to the package, and pretty soon the coalition of interests gunning to shoot it down will be far larger than the coalition willing to support it. Don Ogilvie, the independent chairman of Deloitte's Center for Banking Solutions and a former CEO of the American Bankers Assn., has a similar take: "People in key positions…said 'that's going to be a fight,' and fights take a long time in Washington." Citing "the old 80-20 rule," Ogilvie argues that it's easier to get 80% of something done if you leave behind the 20% that would take 80% of the effort to accomplish.
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