Regulatory Reorganization

Posted on April 8, 2008 by David Laidlaw 

Every major market upheaval brings new regulatory initiatives to try to prevent future problems. The stock market plunge and bursting of the technology bubble in 2000 ushered in Sarbanes-Oxley which imposed strict controls concerning the accuracy of financial reporting. In response to the current credit crisis, the Treasury Department has proposed a radical reorganization of how financial entities are regulated at the Federal and State levels. These plans were first proposed in blueprint form in June of last year and the main focus of the original proposal was to increase the competitiveness of US financial markets.

Treasury Secretary Paulson recommended that a future regulatory framework consist of three agencies with broad powers according to an “objectives-based approach.” These agencies would include a Market Stability Regulator, Prudential Regulator and Business Conduct Regulator.

The Market Stability Regulator would expand the Federal Reserve’s function to insure the smooth functioning of the overall financial system and allow it to oversee all other regulators within the system. The Prudential Regulator would oversee all firms with explicit government guarantees such as Federal Deposit Insured banks to make sure their capital is adequate to cover their liabilities. Finally, the Business Conduct Regulator would include the functions assumed by the Securities and Exchange Commission and the Commodity Futures Trade Commission. This entity would regulate business processes and ensure adequate disclosure within the system.

Paulson’s plan goes further in that it provides for streamlined regulation of state-chartered banks. It also allows for federal regulation of insurance companies which are now regulated by each of the 50 states. Responding to the mortgage crisis, the Federal Reserve also recommends an agency to oversee mortgage origination.

Even though no regulatory framework will prevent future financial problems, this reorganization makes sense from an oversight and efficiency perspective. To handle the current problems, the government and Federal Reserve have basically been stretching their mandates to prevent panic in the markets in ways far beyond their charters. For example, the Federal Reserve has never put $29 billion of its capital at risk to bail out a broker-dealer as it did with Bear Stearns.

The current system is also redundant and it is very difficult for the firms themselves to comply with all of the various regulations issuing forth from various agencies. Many financial services firms are regulated by numerous federal agencies and state regulators. For example, our business is regulated by the SEC, the CFTC, the Department of Labor, the Financial Industry Regulatory Authority and the states of New York, Delaware, Connecticut, California, Texas and Pennsylvania. Any system that streamlined the process and allowed for better oversight should be welcomed by the public and the regulated entities. However, the bureaucratic turf wars that will result from this proposal suggests that nothing will happen quickly since those regulators losing their influence will fight the hardest to maintain the current system.