WASHINGTON — Nearly five months after he took office and amid signs that the worst of the economic storm may be over, President Barack Obama this week rolls out his proposal for revamping federal regulation of the nation's financial markets.
This proposal will be the broadest rewrite of financial regulation since the aftermath of Great Depression. It will reshuffle the responsibilities of regulators, create new protections for consumers and investors, and should, for the first time, bring giant financial players such as hedge funds and private equity companies under direct federal supervision.
Some of the steps can be taken by executive action. The Obama administration already has announced some new regulations, such as limiting the number of oil contracts that big financial institutions can buy and forcing complex financial instruments called derivatives to be standardized and traded on an exchange with government oversight.
Other steps will require Congress's approval, and in the weeks leading up to Wednesday's formal launch, the administration has floated numerous trial balloons to gauge public and political support for a number of its proposed regulatory revisions.
"We're going to have a major public policy correction, since it's the worst financial disaster since the Depression," said Robert Litan, an expert on regulation at The Brookings Institution, a center-left policy research group. "The major features of the plan have been widely reported or leaked, so I would say that the proposal will be far reaching, but not as comprehensive and far-reaching as one would have anticipated three months ago."
Although the proposals seek to rectify lax federal regulation and a lack of discipline on the part of the private sector, the finance sector is putting on a brave face.
"For the most part, the industry actually supports regulatory reform. The key will be separating the politics from the policy," said Scott Talbott, senior vice president of government affairs for the Financial Services Roundtable, the trade group for big finance.
One of the more controversial proposals expected from Obama would give the Federal Reserve greater power to act as a systemic risk regulator. This would expand the Fed's mission, most often associated with fighting inflation and setting interest rates.
One of the saddest lessons of the current financial crisis, the worst in seven decades, is that while several regulators saw bits and pieces of a mounting problem, no single entity knew what was going on across the entire financial sector.
That encouraged big financial companies to shop around for the regulator of least resistance, or in the case of mortgage finance gave rise to non-bank lenders that escaped virtually all federal oversight. Opaque financial instruments flourished with virtually no government supervision.
To remedy this, Obama wants to have the Fed gauge whether companies that are deemed so big that they pose a risk to the global financial system have adequate reserves in case the economy sours. The Fed and other regulators will expand reporting requirements and look at a wider scope of a bank's investments.
The Federal Deposit Insurance Corp. and the Treasury Department are likely to get special "resolution powers" to allow them to dissolve large financial institutions outside the bankruptcy process. The absence of these powers forced the Bush administration to rescue insurer American International Group, and that commitment has cost taxpayers more than $180 billion.
"I would suggest to you that our financial system is not fail-safe until it is safe for failure," Larry Summers, Obama's chief economic adviser, said Friday, signaling that this issue will be a target of new regulation.
Some lawmakers worry that too much power may be placed in the hands of the autonomous Fed. That's given rise to calls for a "council of regulators" or a "financial stability council," that at minimum would work alongside the Fed in policing financial markets for systemwide risks.
This council also would close regulatory black holes that pose a system-wide risk "when risky products or activities fall outside the authority of existing federal financial regulators," said Sen. Susan Collins, R-Maine, a supporter of the approach.
Other Republicans are uncomfortable with labeling some banks as being risky to the system.
"We also are against the concept of firms being designated as systemically risky because we believe that gives an unfair advantage in the marketplace. We've already seen that," said Rep. Randy Neugebauer, R-Texas. "We saw that the government got in the picking winners and losers by determining who was systemically risky and who was not. That's not good policy for this country."
Treasury Secretary Timothy Geithner said recently that he's open to the idea of a "council" approach, but that the administration wants a single entity, the Fed, to have the lead on system-wide vigilance.
Currently, the Fed, the FDIC, the Office of the Comptroller of the Currency, the Office of Thrift Supervision and the National Credit Union Administration each regulate portions of the banking system.
The Securities and Exchange Commission, the Commodity Futures Trading Commission and the Federal Trade Commission are charged with protecting investors from fraud and market manipulation. The Bush administration proposed merging these the SEC and CFTC and combining two banking supervisors, but the Obama administration is expected to maintain the status quo.
"The (stock) market bounce back . . . has taken edge off of panic. That breathing room allowed time for industry views to get a wider hearing," said Litan, adding that it's "certainly cooled enthusiasm" for more aggressive revamping of regulators.
Key committee chairmen have helped shape the Obama plan, but that's no guarantee of smooth sailing since the financial sector has greased many a political campaign.
On June 11, Sen. Christopher Dodd, D-Conn., the chairman of the Banking Committee, outlined plans to create the equivalent of a Consumer Product Safety Commission for financial and credit products. This idea involves taking away from the Fed some powers to regulate credit card companies, payday lenders and others that make loans to consumers. It's expected to be included in Obama's plan Wednesday.
"During the Bush administration, the cops on the beat went on a coffee break while millions of Americans were led into mortgages they couldn't afford. If this financial crisis has proven one thing, it is that protecting the financial well-being of American consumers should be our first priority," Dodd said in a statement.
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