Friday, January 29, 2010

New Financial Sector Regulation

One week ago Thursday, and again during his State of the Union Address, President Obama announced his plan to regulate the financial markets in a way that seeks to eradicate the problems that led to the financial meltdown. During the State of the Union, Obama affirmatively stated that if the financial reform “bill that ends up on my desk does not meet the test of real reform, I will send it back until we get it right.” Snap-polls conducted during his speech found this portion of the State of the Union to be one of the most popular themes raised by the President. Citizen anger at investment banks and Wall Street remains high, and it appears as though President Obama will not leave financial reform solely in the hands of Congress. What does the President see as “real” reform? Here are some of the key provisions from the formal proposal:

First, the Government must have some the ability to manage future crises: Legislation should allow the government emergency authority to take over and unwind large, failing financial institutions. In the case of banks, the FDIC would act as conservator or receiver and the SEC would take over in the case of broker dealer or securities firms. The Treasury would have the authority to decide when a firm is failing and whether a conservatorship, receivership or some other method is appropriate. This is reminiscent of what was proposed by Paul Krugman and others back in early 2009 that nationalization was the best way to stabilize the financial markets. This is the authority that Secretary Geithner suggested to Congress was needed last August.

Second, new regulation of financial firms is necessary: The President proposes that any bank that poses systemic risk will be closely monitored and regulated by a “fundamentally adjusted” Federal Reserve oversight system that includes the use of stress tests to determine the viability of the financial firm. The Treasury would be given the power to re-examine capital standards for banks and bank-holding companies. The legislation should fill the gaps in the federal regulatory scheme by drastically expanding the number of firms under federal regulation by requiring hedge funds, private-equity funds and venture-capital funds to register with the SEC and would force industrial banks, non-bank financial firms and credit-card banks to become more traditional bank holding companies subject to federal oversight.

Third, guidelines on executive compensation should be adopted: Regulators would issue guidelines on executive compensation, with the goal of aligning pay with long-term shareholder value, including a re-examination of the utility of golden parachutes. New legislation would also require non-binding shareholder votes on executive compensation packages.

Fourth, new regulation would be adopted for securitization of asset-backed securities: Obama’s proposal requires originators of securitized products, like mortgage brokers, to retain some economic interest in securitized products.

Fifth, the creation of a consumer financial protection agency would be effectuated: This new agency would play a “leading role” in educating consumers about finance and would promote the use of “plain vanilla” products, such as mortgages, which would have to be offered by companies.

With two different financial regulation bills currently weaving through the House and the Senate, and now with new proposals being introduced by the White House, it will be very interesting to witness what emerges from Congress and how significantly the regulatory pendulum will swing in 2010.


  1. It certainly will be interesting to see what type of regulations will be imposed on Financial institutions. I truly believe that there should be some oversight over the banking industry. However, I am somewhat on the fence about the entire issue. I see how the President feels the need to regulate these companies, as many Americans heavily rely on them with savings of great value. On the otherhand, I'm not sure how much the government should be infringing on private coporations. I certainly understand the argument that these companies owe the American people for bailing them out with their tax dollars. But what about once these companies fully repay their debt to the people? Oppose to bailing the companies again, is it best to just let them go insolvent and let the free market play itself out?

    I will be certain to follow how these regulations play out over the next several months, if not years.

  2. I understand concern about over regulation but the lesson to learn from the last financial crisis is that we can't just let these banks fail under our current regulatory regime which creates a substantial moral hazard problem. These banks are literally too big to fail - its not a decision of ideology about the role of government - but of the collapse of the economy. One of the most important goals of this regulation is to provide a framework to break up financial institutions that are failing without inducing the panic that we saw after Lehman went under. This isn't really about repaying the corporations debt to society but creating an economy that isn't giving an implicit guarantee to the actions of too big to fail financial institutions.

  3. Too big to fail must be deal with affirmatively. If the new regulations do not provide mechanisms to break up or break down TBTF institutions, then was have learned nothing from the recent collapse.

  4. Government intervention in the financial sector is very much needed to ensure that the recent melt of the financial industry we’re experiencing does not happen again. Our “free market” is based on the idea of government-free participation, however that is an ideal. In reality, a host of other factors come into play fueled by financial greed and burdensome-free gain in the free market. Government intervention of the financial industry, I believe will help minimize, if not eliminate the less than ethical practices and serve as a deterrent for institutions to follow efficient financial policy. The President has also proposed that the shareholders have a say so in executive compensation, as well as aligning their pay with the “long-term shareholder value." This would enable companies to stay committed to their shareholders by not taking shortcuts that will have devastating consequences down the road. Government intervention coupled with increased shareholder participation would be a good start to shaping the new financial market. It will be very interesting to see what comes of these proposals to our legislature in the future.

  5. Government intervention in the form of the nationalization of financial markets may provide a hot topic for conversation, but in reality nationalization of financial markets and firms is the wrong approach for finding a solution to today's current economic woes. The popular trend in our country today is to focus on a short term solution that will yield fast, postive results for everyone; in doing so, it is easy to push blame onto those who are blameworthy. And certainly the large corporations of America are greatly responsible for the present rescession. However, to allow the federal government to nationalize private industries goes against the very economic principles upon which our great nation was founded. The US economic system regulates itself over time; the only way to build a stronger national economy is to allow weak players to leave the market. While laissez-faire may not be an appropriate market structure for today's America, heavy, instrusive government regulation will do more to harm the economy than help. The government should help to guide the invisible hand; but that hand should not merely be an extension of the federal government.

  6. I don't believe Wall Street will go for number 5. This isnt the first time America has run into these problems with bad investments yet change seems unrealistic. Why is it that every time after an economic downturn or crisis legislature finally see's the loopholes in the system? Legislature only cares about the people during re-election. All the arguments about the market regulating itself are fair, however, the true free market theory does not run properly when crooks are involved. Regulation is needed!