The Obama administration has put forward an excellent blueprint for regulatory reform. Much of what the administration has proposed will increase transparency, reduce the risk of another financial meltdown and improve investor protection.
However, there are some proposals that might be questioned, and the devil is in the details that must be filled in by Congress, which will write the laws to implement them.
Although financial market reform can't, and shouldn't, remove all risk from investing — the stock and bond markets will always react to economic developments, and developments within specific enterprises — the proposed reforms, if carefully tweaked, should reduce the chances of another major financial meltdown.
In addition, most of the proposals, directly or indirectly, could help protect individual investors from fraud.
The creation of a Financial Services Oversight Council is an excellent idea. The council will facilitate information-sharing and coordination among the
Commodity Futures Trading Commission, the Department of the Treasury, the Federal Deposit Insurance Corp., the
Federal Reserve Board, the Securities and Exchange Commission and several other agencies to identify firms whose failure could create a threat to the nation's financial stability.
It will provide more transparency, and it will help prevent institutions playing one regulator against another.
The new council should serve as an early-warning system to alert regulators to brewing problems and allow timely action to head them off before they threaten the entire financial system.
Perhaps if this council had existed two years ago, the world wouldn't have plunged into a financial crisis.
A number of other proposals address the weaknesses that contributed to the meltdown.
The administration proposes that the federal banking agencies be asked to promulgate regulations that would require originators or sponsors of securitized-debt obligations to retain 5% of those securities on their own books. This should inspire originators to be more careful about the securities they originate.
What's more, the proposal recommends that the SEC be authorized to continue efforts to increase the transparency and standardization of the asset-backed-securities markets.
It also proposes that the SEC continue its efforts to strengthen the regulation of the credit rating agencies. In particular, the SEC is urged to improve the policies regarding disclosure and management of conflicts of interest at those agencies.
These proposals, besides reducing the chances of another crisis caused by the bursting of an asset-backed securities bubble, would make asset-backed securities less risky for individual investors.
The reform proposal also would give the SEC expanded authority to promote more transparency for investors. The agency would be given authority to establish a fiduciary duty for broker-dealers offering investment advice and to “harmonize the regulation of investment advisers and broker-dealers.”
Also helping to reduce the chances of another derivatives-driven bubble is a proposal that all over-the-counter derivatives, including credit default swaps, be subject to comprehensive regulation, focused on promoting efficiency and transparency, and the prevention of market manipulation and fraud.
Among the proposals that will be questioned is one to give the
Federal Reserve Board increased powers in its role as key regulator of large financial holding companies. Some in Congress have already pointed out that the Fed has a huge responsibility in simply managing the country's money supply and regulating federal banks, and that additional power might stretch it too thin.
No doubt special interests will challenge many parts of Mr. Obama's proposals, such as the proposed power of the new Consumer Financial Protection Agency to “place tailored restrictions on product terms and provider practices.”
Congress has a tough task ahead and it shouldn't be rushed.
Legislators must weigh the comments and objections, consider what is in the long-term interest of the economy, and produce a regulatory-reform bill that protects the financial system and investors without stifling investment and economic growth.
