Treasury Secretary Henry Paulson proposed the broadest overhaul of U.S. financial regulation since the Great Depression, saying the system for overseeing American capitalism needs to be better prepared for ``inevitable market disruptions.''
``Our major financial services companies are becoming larger, more complex and more difficult to manage,'' Paulson said in the text of remarks at the Treasury's headquarters in Washington.
Paulson's 218-page ``Blueprint for Regulatory Reform,'' commissioned two months before credit markets seized up in August, said more rules aren't ``the answer'' to the current period of turmoil. The former chairman of Goldman Sachs Group Inc. said the structure of regulating banks, securities firms and insurance companies is outmoded, and the Federal Reserve should expand its oversight of financial services beyond banks.
``We should and can have a structure that is designed for the world we live in, one that is more flexible, one that can better adapt to change, one that will allow us to more effectively deal with inevitable market disruptions, one that will better protect investors and consumers,'' Paulson said.
The Fed, which earlier this month engineered JPMorgan Chase & Co.'s purchase of Bear Stearns Cos. and became lender of last resort to the biggest bond dealers, will oversee ``market stability,'' under proposals Paulson unveiled. The Securities and Exchange Commission, traditionally the main regulator of Wall Street firms, will be merged with the Commodity Futures Trading Commission.
Most of Paulson's proposals will require congressional approval.
New Fed Authority
The Treasury recommended that the Fed share authority over banks, securities firms and insurers in monitoring corporate disclosures, writing rules and stepping in to prevent economic crisis.
``To do its job as the market stability regulator, the Fed would have to be able to evaluate the capital, liquidity and margin practices across the financial system and their potential impact on overall financial stability,'' Paulson said.
The plan also suggests a distinction be made between the Fed's ``normal'' lender-of-last-resort discount window to help banks meet short-term funding needs and ``market stability'' lending to help stave off funding shortages and panics. In that function, loans could be extended to federally chartered insurers and financial institutions.
``The Fed must have the necessary information to perform its role as it temporarily provides liquidity to non-banks,'' Paulson said. ``But it would be premature to assume these institutions should have permanent access to the Fed's discount window and permanent supervision by the Fed.''
No `Comprehensive Design'
Changes to the U.S. regulatory system, parts of which date back to the Civil War, have been proposed in the past, only to be thwarted in Congress and frustrated by industry opposition. The Presidential election will make it harder for the Bush administration to push through changes in its final year, said Bill Isaac, who was chairman of the Federal Deposit Insurance Corp. between 1981 and 1985.
``It's a lame duck administration, so it automatically means they have less credibility than they would have if they were in their first year,'' said Isaac, who now heads The Secura Group, a financial consulting firm in Vienna, Virginia. ``And the known devil is better than the unknown devil in the minds of those who are regulated.''
Reich Bets on Survival
John Reich, director of the Office of Thrift Supervision, said he's skeptical that the combination of his agency with the Office of Comptroller of the Currency, as proposed by Paulson, will be easily achieved.
``Expect to see news stories and renewed questions about what the future will hold,'' Reich wrote in letter to employees on March 28. ``The 20th anniversary of the OTS is next year. We can all expect -- despite predictions over the years to the contrary -- to be celebrating it.''
The OTS, a Treasury division created in 1989 after the savings-and-loan crisis, oversees lenders including Calabasas, California-based Countrywide Financial Corp., the biggest U.S. mortgage lender, and Seattle-based Washington Mutual Inc., the largest U.S. savings and loan.
``The bulk of these regulatory responses made sense at the time they were created, but as we look at today's financial markets, the lack of a comprehensive design in clear,'' Paulson said. He added that ``with few exceptions, the recommendations in this blueprint should not and will not be implemented until after the present market difficulties are past.''
Political Obstacles
In his letter, Reich outlined obstacles to Paulson's plan, saying congressional debate and hearings could stretch into next year, when a new Congress and a new president ``may well have their own priorities and agendas.''
A dozen similar efforts by presidents, legislators and others over the last 60 years never ``became reality,'' Reich wrote. His office distributed the letter to reporters on the weekend.
He also said there was a lack of industry support for restructuring the regulatory system, including opposition from the American Bankers Association to merging the OTS with another agency.
Treasury's proposal would ``create a more coherent supervisory scheme'' by ending ``some of the inconsistencies arising from today's patchwork system,'' Lou Crandall, chief economist at Wrightson ICAP LLC, a Jersey City, New Jersey-based research firm, said in a report.
`Moral Hazard'
Still, expanding the Fed's role to stabilize markets would exacerbate the ``moral hazard problems'' stemming from the central bank's decision to lend money to investment banks after the near-collapse of Bear Stearns, said Crandall, who used to work at the New York Fed.
So-called moral hazard is the notion that bailouts encourage financial companies to take risk because they assume the government will always come to the rescue.
``The Fed would have the authority to go wherever in the system it thinks it needs to go for a deeper look to preserve stability,'' Paulson said.
``The Fed will collect information from commercial banks, investment banks, insurance companies, hedge funds, commodity-pool operators,'' he added. Rather than focus on the health of the particular organization, it will focus on whether a firm's or industry's practices threaten overall financial stability.
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