The Administration's backtracking on regulatory reform has some critics saying that a rare opportunity is being squandered
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. In an op ed article in the June 15 Washington Post, Geithner and Lawrence Summers, director of the National Economic Council, said their goal is "to create a more stable regulatory regime that is flexible and effective; that is able to secure the benefits of financial innovation while guarding the system against its own excess." The plan will try to rein in systemic risk by "raising capital and liquidity requirements for all institutions, with more stringent requirements for the largest and most interconnected firms." It will give the Federal Reserve the power to unwind financial holding companies whose failure could threaten the world's economy. And it will try to strengthen consumer and investor protections on products ranging from "credit cards to annuities."
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 crisis 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.
"If you want to get something done in Washington, it's always a good idea to get it done quickly," says Ogilvie, "because if it bogs down, it tends to be pretty difficult to un-bog."
Geithner adamantly denies that the recovery and a diminishing sense of crisis are lowering the impetus for reform. "I don't see any signs of that yet," he said at a press briefing before leaving for the G-8 talks over the weekend.
And following those talks in Italy, Geithner reiterated his commitment to a strong package of reforms to lessen the risks both at home and abroad. The Administration's upcoming proposals will not only include comprehensive reforms for the U.S., Geithner said in a statement, they will also offer more conservative standards for oversight of the most active international financial institutions as well as global markets such as derivatives.
"Because risk does not respect borders, we will put forward several international proposals in our reform package that will help to raise standards globally," Geithner said.
obama's m.o.: Lots of Talk, Less Action?
Still, some critics sense that the Administration is about to fumble an opportunity—and follow a pattern increasingly seen throughout this Administration's policy agenda: strong language followed by actions that appear far weaker than the rhetoric.
Take the Administration's new proposals on executive pay. For months, officials from the President on down have been talking about the need for wide-ranging changes to the executive-pay practices they believe contributed to the financial crisis. Yet when Geithner announced a series of proposals on June 10 aimed at reigning in excessive compensation and ensuring that pay structures don't encourage traders and executives to take excessive risks to boost short-term pay at the expense of the long-term stability of their companies, the measures were much less stringent than many had expected—or corporate executives had feared.
"They've proven to be fairly moderate in this area," says Michael S. Melbinger, head of the compensation practice at Chicago's Winston & Strawn, who says the measures don't go much beyond what is already becoming best practice at many companies. Moreover, despite backing for legislation that would authorize shareholders to hold nonbinding votes on executive compensation packages—so-called say on pay measures—and tighten requirements for members of board compensation committees, it is far from clear how the Administration's proposals would truly limit the risk-taking and poor judgment that led to big pay packets followed by the collapse of many financial firms.
"The Administration has put forth several principles for executive compensation that should be followed, but people have understood these principles for a long time," says Jesse Fried, a professor at the University of California at Berkeley and co-author of Pay Without Performance: The Unfulfilled Promise of Executive Compensation. "It can't hurt to have the Treasury Secretary repeat them, though mere repetition is not that helpful. Unless the balance of power between shareholders and executives shifts, I don't see any change coming."
still encouraging debt-driven consumption
Or look at the frequent talk, since the crisis began, of the need to rebalance the U.S. economy away from consumption toward encouragement of more savings and more investment. Over the long run, few quibble any more with the notion that debt-laden U.S. consumers can no longer be the primary engine for growth not only for the U.S. economy but for the global economy as well. But while there is much talk of the long-term need to reduce consumption to sustainable levels, in the short run little or nothing is being done to encourage that shift.
Quite the contrary: Current policies seem designed to get consumers to crank up the debt and consumption machines again. That's the inevitable outcome of current proposals to offer large tax credits for first-time home buyers—even those with little or no savings to make a down payment—or encourage car owners to turn in their old clunkers by subsidizing the purchase of a new car. While certainly useful for getting the economy going in the short term, such moves would do little to spur the inevitable cutbacks in debt that are required.
"Consumer spending is over 70% of GDP. Obama is not going to let it drop to 65%," says Clifton. "He can do the right thing and let the consumer deleverage—and he can also be a one-term President. It's not going to happen."
This isn't solely an American phenomenon. As the sense of crisis recedes, similar questions are arising across the globe over whether governments will pull back from needed changes. As much as the U.S. needs to boost its savings and investment, a healthier global economy will also require the Chinese to lessen their dependence on exports and put more into domestic consumption. While many in China's leadership see a need for fundamental reforms, there are also plenty of others who believe that as the worst of the crisis passes, nothing that extensive is needed.
"Like any leadership, there are people in government there who hope that things will just go back to the way they were," says one senior U.S. Administration official. That could be said of many in the U.S. government as well.
With reporting by Theo Francis