U.S. President Unveils Major Financial Regulations Plan

Minimising Systemic Risks

As announced earlier this week, President Barack Obama has presented a major regulatory overhaul of the banking system in the United States, one that he described as the furthest reaching since the 1930s. Much of the plan presented yesterday tallies with details released earlier this week by Treasury Secretary Timothy Geithner and White House Economic Adviser Larry Summers (see United States: 16 June 2009: U.S. Administration Forges Ahead with New Financial Regulations Reform).

Under the proposal, the Federal Reserve will see its powers increase dramatically, with special supervisory authority over large financial institutions and banks whose collapse would pose a structural threat to the system and the economy. It will have full powers to take over such institutions should they be in financial trouble. In addition, these firms will also all face tougher capital requirements in order to mitigate risks and prevent high-risk activities.

A Financial Services Oversight Council is to be set up as the new co-ordination platform from which all major regulators will act to improve and tighten the supervision of the system. It would be in charge of identifying which firms are to fall under the Fed's scrutiny. The Office of Thrift Supervision is to be eliminated and replaced by a National Bank Supervisor, which will also take on the duties of the Office of the Comptroller of the Currency. Another regulatory body, the Consumer Financial Protection Agency, is to be created to protect consumers' and investors' interests against the abuses and vagaries of the mortgage and credit markets. Under the aegis of the agency, loan issuers would have to retain 5% of the credit risk. It would also set standards for "plain vanilla" products: that is, easy-to-understand straightforward mortgage, credit card, and other financial products. Additional protection for consumers and investors will also be provided by the Federal Trade Commission and the Securities and Exchange Commission, whose remits are expanded in that sphere.

Regulatory tightening will also affect securitisation and over-the-counter derivatives. The latter will be subject to a centralised clearance system and limited to a "transparent" trading mechanism. As for issuers of asset-backed securities, they face a new battery of regulations in the form of strengthened reporting requirements, and retain at least 5% of performance risk—a measure that will also affect securitisation sponsors and brokers. The "gain on sale" accounting principle would be totally eliminated. As for securitisation oversight processes, they will be strengthened and homogenised.

Outlook and Implications

Too Far or Not Far Enough?

Reactions yesterday were widespread and mixed, ranging from praise to criticism. In the opposition and in the private sector, the stepping-up of the state's presence in the sector was ill received. For many this implies more cumbersome bureaucracy and a new layer of supervision that will only prove ineffective. The new powers of the Fed are facing particular criticism. New regulations and monitoring practices are considered to be barriers to new market innovation and stimulation. Others see the plan as spreading itself too thinly over a wide array of areas, arguing that additional deeper regulatory moves are required. The absence of any clear-cut regulation of credit ratings agencies was also a major disappointment. For those who have expressed approval, the element of tougher supervision—especially in the area of consumer protection and tightened capital requirements—appears to be key.