Thursday, April 03, 2008

More thoughts on Fed oversight

On Monday we talked about the government's recently proposed plan to further Federal Reserve oversight of the financial markets and create a regulatory superagency to oversee "both investor protection and market stability" (LA Times quote).

I thought we'd follow up on this with some facts, and a bit of commentary from both sides. You'll hear the bright side, and get a view of the downside to this recent proposal. Shall we begin?

We'll start with an overview that lays out the nuts and bolts. Here's the Economist's recent take on the "Paulson plan" to revamp the US system of financial regulation.

"The Treasury plan envisages several phases of reform. Short-term goals include the expansion of the President's Working Group (PWG), now a club for only select large regulators, and the creation of a federal Mortgage Origination Commission.

This would consolidate oversight of a process that has wreaked havoc on balance sheets. It is also seen as a partial solution to the problem of dodgy securitisation, as the commission would grade the underwriting of loans going into pools. Critics point out, however, that it would create another layer of bureaucracy, since regulation of mortgage brokers and many lenders would stay with the states.

In the long run, say between two to eight years, Mr Paulson hopes to see a new regulatory architecture, with today's hotch-potch folded into three “objectives-based” agencies that some see as similar to the Australian system. That means a remodelled Federal Reserve with an eye on overall market stability; a prudential regulator for banks and thrifts, which would mean the demise of the Office of Thrift Supervision (OTS); and a business-conduct agency, taking in much of the SEC's oversight of disclosure and the like."

Now, the Economist piece notes that the rationale behind this unifying plan is to correct the present set-up which is "Balkanized and inefficient". But then, this sounds like the same line that you hear whenever people are arguing in favor of a new regulatory scheme or a roll-up and enlargement of an existing framework.

Indeed, this is the view offered by writer, Ian Welsh, over at the Huffington Post. I don't usually bother to read this site, but I was caught by his article title, which had a certain ring of truth to it. Here's an excerpt from, "The Paulson Plan: Doing What He Wanted to Do Anyway":

"So Paulson has come out with a plan. It's primarily a reorganization plan, pushing the Thrift regulator into the SEC, creating a federal mortgage regulator, giving the Fed the right to inspect the new firms that now have access to its liquidity. There's some talk about objectives based It's almost always a bad sign when the primary "reform" is to create new agencies or merge old ones and Krugman is right to ridicule it as The Dilbert Strategy."

Welsh goes on to outline his view of the proposed regulation scheme and its shortcomings, but does not question the idea of Fed regulation itself. He seems more concerned from a pragmatic view, that the plan will not make the needed corrections, and criticizes the plan as a meaningless "shock therapy" mandate designed to push through long-desired legisition.

So I went looking for upsides to the plan, and checked out a recent Bloomberg article on the Fed's new market authority. It turns out almost everyone there was down on it too.

Some excerpts:

``It would be Congress and the president essentially giving a blank check to a regulator over which they have very little power,'' said Michael Greenberger, a professor at the University of Maryland in Baltimore and a former CFTC official. Paulson's proposal will ``allow Wall Street to do whatever they want until a crisis occurs, at which point the Fed would intervene.''

"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.

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."

But don't worry, I found a quote in favor of the plan to merge regulatory agencies...from SEC Chairman Christopher Cox.

"Just as systemic risk cannot be neatly parceled along outdated regulatory lines, the overarching objective of investor protection can't be fully achieved if it fails to encompass derivatives, insurance, and new instruments that straddle today's regulatory divides,'' Cox said in a statement on March 29."

Here's more debate on the plan in a recent Bloomberg video collecting soundbites from various commenters. You'll hear comments from John Snow, Arthur Levitt, Harvey Kauffman, Michael Oxley, Marshall Front, Jeremy Siegel, and others.

Most of the government guys and former regulators seem to favor the proposal (or parts of it), while Marshall Front likens the plan to common after-the-fact regulatory proposals which end up having adverse unintended consequences for business and the economy.

So far, I'm having a hard time finding anyone (besides the regulators and the investment banks) who's in favor of the Paulson plan for increased Fed oversight of the financial markets. It turns out even the Fed is giving this plan the thumbs down.

So in the interest of lending an ear to some added voices, let me link to some additional commentary from writers and bloggers who have been looking at this issue. You may find some positive outlook in the blog search link I'll include, but you may have to sift for it.

"Paulson's Injustice to the Trial and Error Economy" - Seeking Alpha.

"Don't discount Paulson" - LA Times.

"Giving the Fed more (less?) regulatory power" - Marginal Revolution.

"Stemming the Tide" - BMB and Minyanville's Andrew Jeffrey.

"Market Manipulation Under Veil of Secrecy?" - Mr. Practical.

"Paulson's Civic Robbery to Finance Hyperinflation" - John Browne.

Various blogger posts on the Paulson plan - Google blog search.