Financial Regulatory Reform ECO 238 12/07/2009 “Over the past two years, we have faced the most severe financial crisis since the Great Depression. The financial system failed to perform its function as a reducer and distributor of risk. Instead, it magnified risks, precipitating an economic contraction that has hurt families and businesses around the world.” (Geithner & Summers) While the current crisis had many causes, it is clear that the government could have done more to prevent many of the problems from growing out of control and threatening the stability of our financial system. Gaps and weaknesses in the management and regulation of financial firms presented challenges to our government’s ability to monitor, prevent, or address risks as they built up in the system, which caused the enormous bailouts or the massive financial collapses of financial institutions. The previous approaches to bank holding company regulation focused on protecting the subsidiary bank, not on the comprehensive regulation of the whole firm. In June, the President, proposed a new financial regulatory plan for the financial system. The new reform, as mentioned by the President, would protect consumers, impose new restraints on financial institutions and guard against the dismal practices that caused the market crisis. The new reform would generally be adopted by regulators since it mostly affects them. Timothy Geithner who is the secretary of the Treasury and Lawrence Summers who is the director of the National Economic Council wrote that “the 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 proposed reform had five main objectives. They were: to promote strong supervision and regulation of financial firms, to establish a comprehensive supervision of financial markets, to protect consumers and investors from financial abuse, to provide the government with tools it needs to manage financial crises, and to raise international regulatory standards and improve international cooperation. The first objective is to “promote robust supervision and regulation of financial firms.” The first objective argues that financial institutions that are critical to market functioning should be subject to strong oversight. The aftershock of crisis tells us that no financial firm that could pose a significant risk to the financial system should be unregulated or weakly regulated because very much depends on it. The government assumes that they need a clear accountability in financial oversight and supervision of the major financial firms. In going forward with the plan a new Financial Services Oversight Council will be created of financial regulators. The new council will be composed of the Treasury secretary and the heads of seven agencies. The council will identify firms that could pose systemic risk or market risk. Systemic risk affects the entire market and cannot be diversified. The council will also resolve jurisdictional disputes among the agencies or improve the cooperation between them. Also, a new authority for the Federal Reserve will be given to supervise all firms that could pose a threat to financial stability or jeopardize the stability of the financial system. New standards and stronger capital will be required for all financial firms. Understandably, higher standards will be required for large and interconnected firms because more depends on them and very much damage will occur if only one of those large firms would crash such as the Lehman Brothers. Large firms would need to raise stronger capital to hold against losses, in other words to have a secure future. Some large financial institutions disagree with that measure because it would reduce their profitability and make them less competitive with smaller companies that have lower capital rates. A new National Bank Supervisor will be created by the merger of the Office of the Comptroller of the Currency and the Office of Thrift Supervision. The Thrift charters would be eliminated and would become commercial banks. The elimination of the federal thrift charters and other loopholes happened because it allowed some banks to avoid the bank holding company regulations held by the Federal Reserve System. The new National Bank Supervisor would regulate and supervise all federally chartered depository institutions or banks. Hedge fund advisers with assets under management exceed a given point and other private pools of capital will be required to register with the Securities and Exchange Commission and open their books to the regulators under the Investment Advisers Act. The advisers should be required to report information on the funds they manage that is adequate to assess whether any fund poses a threat to financial stability. The second objective of the proposed reform is to “establish comprehensive supervision of financial markets.” The purpose of the objective is that the major financial markets must be strong enough to withstand both system wide crisis and the failure of one or more large institutions. To achieve the goal enhanced regulations must be imposed on the securitization markets. The requirements will include market transparency, stronger regulation of credit ranking agencies, and, that issuers and originators must retain a financial interest in securitized loans. Also, the new reform requires a complete regulation of all over the counter derivatives including the Credit Default Swaps by the Commodity Futures Trading Commission and the Securities and Exchange Commission. The OTC Derivatives and CDS should be regulated because of several reasons and they are: to prevent the activities in those markets from posing risk to the financial system, to promote the efficiency and transparency of those markets, to prevent market manipulation and other market abuses, and to ensure that OTC derivatives are not marked improperly. The Federal Reserve would have a new authority and responsibility to oversee important payment, clearing and settlement systems, and activities of financial firms. The third objective of the financial regulator reform is to “protect consumers and investors from financial abuse.” After the shock of the recession, the government needs to rebuild a trust in the market. The market needs strong and consistent regulations and supervision of consumer financial services and investment markets. The purpose of this objective is to promote transparency, simplicity, fairness, accountability, and easy access to the financial markets by the consumers and investors. To achieve this aim a new Consumer Financial Protection Agency will be created to protect consumers of credit, savings, payment, and other consumer financial products and services. The agency will protect consumers across the financial sector from unfair, deceptive, and abusive practices. The agency will also set and enforce rules regarding the consumer loans, like credit cards and mortgages. Stronger regulations will be imposed on the consumer and investor products and services to improve the transparency or disclosure, fairness, simplicity or straightforward pricing and access. Higher standards will be required for providers of consumer financial products and services and it doesn’t matter if they are part of a bank. The fourth objective of the proposed reform is to “provide the government with the tools it needs to manage financial crises.” To avoid the next financial crisis and the bailouts that occur as a consequence the government needs to be prepared and should contain the needed tools to manage crises if they occur. During this crisis the government constantly needed to deal with only two choices between the bailout or a financial collapse. An example of a bailout is the automotive industry and an example of a financial collapse that occurred during this financial crisis is the Lehman Brothers or Bear Stearns. A new administration to resolve nonbank financial institutions whose failure could have serious systemic effects. Also, the revisions to the Federal Reserve’s emergency lending authority to improve responsibility. The section will be amended where a prior written approval of the Secretary of the Treasury was required for any extensions of credit by the Federal Reserve to individuals, partnerships, or corporations in unusual circumstances. (Akesson) The fifth objective of the financial reform is to “raise international regulatory standards and improve international cooperation.” The government is trying to say that other countries should set high regulatory standards as well because the challenges that the people in US face are global challenges. Some of the proposals include international reforms such as strengthening the capital structure, to improve the supervision of global financial markets especially improved oversight of credit derivative and other OTC derivative markets, to organize the supervision of international financial firms, and to enhance the crisis management tools and methods such as improving the liquidity risk management standards or enhancing the oversight of the credit rating agencies. The Financial Regulatory Reform contains a significant reconstruction of the regulatory system. The reform proposes the creation of the Financial Services Oversight Council and two other new agencies, such as Consumer Financial Protection Agency and the National Bank Supervisor. Also, to promote national coordination in the insurance sector, the Office of National Insurance within Treasury will be created. The Federal Reserve and the Federal Deposit Insurance Corporation will have total authority to oversee any large financial unit. The FDIC would also have a new authority to take over and shut down financial institutions whose failure could pose a systemic risk. The National Credit Union Administration will maintain its powers of the credit unions. The SEC and the Commodity Futures Trading Commission will remain as the market regulators. The proposed Financial Regulatory Reform is not perfect nor does it contain the complete set of the desired and needed reforms for the financial regulation in the current market. The reform focuses on the current crisis and more could be done in the future. The need for a more stable financial system that is fair to the customers and investors is essential. The reform also will help prevent and contain any potential crises and recessions in the near and hopefully far future. For the reform to take the complete effect, it will require some time for implementation and justification time. The government hopes the reform to take effect late this year or next year. References _ _Akesson, Alex. Nov 20, 2009. http://www.hedgeco.net/blogs/2009/11/20/summary-of-recomendations-from-financial-regulatory-reform-a-new-foundation/ “Financial Regulatory Reform. A New Foundation: Rebuilding Financial Supervision and Regulation.” http://www.financialstability.gov/docs/regs/FinalReport_web.pdf _Geithner, Timothy and Summers, Lawrence. June 15, 2009. _http://www.washingtonpost.com/wp-dyn/content/article/2009/06/14/AR2009061402443.html