Geithner: The Regulatory War Ahead

A broad plan for federal oversight of hedge funds, private equity, and derivatives is drawing approval now. But wait till the details emerge

By Theo Francis

Fresh off his hit performance with the bank-rescue plan, Treasury Secretary Timothy Geithner seems to be on a roll. His broad proposal to overhaul regulation of whole swaths of the financial sector drew applause from most quarters on Mar. 26. Investors didn't seem at all unsettled by the prospect of intensified government oversight, as the Standard & Poor's 500-stock index rose 2.3% and Wall Street closed in on a second straight week of strong gains.

But the plan offered few specifics in many of the areas it addressed, from tougher regulation of complex financial derivatives to new rules for money-market funds. And Geithner steered well clear of some of the most contentious questions facing policymakers—the questions that are sure to turn agreement about broad principles into a pitched, possibly months-long political battle that pits financial interests against consumer advocates and one another.

"It's like with all these programs—the devil's in the details," said Kevyn Orr, a Jones Day attorney who previously worked for the Resolution Trust Corp. as it cleaned up after the savings and loan crisis in the early 1990s.

"Who's going to stand up and say, 'I don't like baseball, mom, and apple pie'?" Orr said. "But you go to Boston and New York, there's a whole lot of differences between Yankees and Sox."

Battles to Come

The Treasury Secretary promised specifics in coming weeks, including separate proposals addressing consumer protection, gaps in U.S. regulation, and ways to coordinate regulatory reform with other countries.

Those details are sure to throw into sharper relief the battles that lie ahead. Many of the proposals will bring some measure of scrutiny to corners of the financial markets that have gone for years without significant regulation, including private equity and hedge funds and the market for most financial derivatives. Defining which institutions should be deemed "systemically important"—whose failure could pose a risk not only to their own investors but to the financial system itself—and imposing stricter capital requirements on them will lead to jockeying among banks, insurers, and fund managers.

Tightening consumer protections—which many Democrats say would go a long way toward preventing another financial crisis—will likely mean restricting mortgage companies and credit-card lenders, among others. Closing regulatory gaps could spark disputes among government agencies and even congressional committees with overlapping or related jurisdiction. Lawmakers on the committees that oversee the Commodity Futures Trading Commission and the Securities & Exchange Commission won't be eager to cede authority to one another, for example.

Game Changers

In making his case to the House Financial Services Committee, Geithner called his proposal "not modest repairs at the margin, but new rules of the game." In focusing on systemic risk, he said regulators must be retooled to look beyond the soundness of individual institutions "but must also ensure the stability of the system itself."

To that end, Geithner renewed calls for a systemic-risk regulator with the authority to monitor and rein in large, interconnected financial companies, whether federal banks or hedge funds and other pools of private investments. He also called for beefing up the capital that big institutions must hold against their liabilities and requiring "leveraged private investment funds" over an unspecified size to register with the SEC and submit to closer scrutiny.