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| Sweeping plan: Treasury Secretary Henry Paulson outlined Monday the biggest overhaul in financial regulation since the Great
Depression. J. Scott Applewhite/AP |
Paulson proposes major new role for the Fed
The central bank would oversee all financial markets, under a new plan.
from the April 1, 2008 edition
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Mr. Roberts compares the effort to the Glass-Steagall Act, passed in 1933, which required the separation of banks and investment banks. Glass-Steagall was revoked in 1999. "We're now saying we need a Glass-Steagall Part II; we made a mistake," he says.
One of the compelling reasons for reform, says Lyle Gramley, a former Fed governor, is the potential for systemic risk – that is, a financial calamity that affects the nation's financial well-being. "We now know we have hedge funds, private equity groups, investment banks [and] we used to lean on market discipline to regulate them," says Mr. Gramley, a consulting economist at the Stanford Group in Washington. "It's not enough. We need some kind of overarching regulation."
However, some critics, particularly in Congress, maintain that the Paulson plan does not go far enough. Sen. Charles Schumer (D) of New York wants regulation of some of the complex new financial instruments devised by Wall Street. "The Treasury Department should address these issues as well," he said in a statement.
Bob Eisenbeis, a former executive vice president at the Atlanta Federal Reserve Bank, says he is disappointed in the Paulson proposal, too. "It's a reshuffling of responsibilities without any concern of underlying efficiency issues," he says.
Under the Paulson proposal, there would be three distinct regulators: the Fed, a new prudential regulator of institutions with federal guarantees, and a new business-conduct regulator, possibly a combination of the Securities and Exchange Commission and the Commodity Futures Trading Commission.
Mr. Eisenbeis says a restructuring is likely to run into resistance. "The regulators are opposed to giving up their power; the institutions have fought it in the past," he says.
Most observers doubt Congress will take up the most sweeping provisions this year. "This is like a birthing process and we are in Month 1," says Mr. Roberts.
Gramley thinks any regulation will have to balance Wall Street's competitive needs with the need for closer supervision. "Those who are going to be regulated will argue [that] if the capital requirements are more onerous than investment banks abroad, it will reduce their competitiveness," he says. "It will be a legitimate concern."
There is also a danger of stifling Wall Street's creativity. Many analysts blame the financial engineering of the 1990s for the current credit market crisis. However, Gramley points out that despite all the problems in the subprime mortgage market, the concept allowed some 5 million to 6 million people who would not have qualified to obtain a mortgage. "It's a definite social good," says Gramley.
•Staff writer Mark Trumbull contributed to this story.
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