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Proposed Treasury ‘Blueprint’ Would Restructure Regulation

By Melissa Hoffmann Lajara, Trusted Professional Staff

NEW YORK—An ambitious plan is being offered by the United States Treasury Department to broadly reconfigure and “modernize” the nation’s decades-old financial regulatory structure.

The plan seeks to slash the number of regulatory agencies that police Wall Street to three. One would regulate banks, another would oversee consumer protection and business practices, and the third, the Federal Reserve, would have the power to regulate any aspect of the markets to ensure stability, according to the Washington Post.

“Government has a responsibility to make sure our financial system is regulated effectively. And in this area, we can do a better job,” Treasury Secretary Henry M. Paulson, Jr., said in a statement. “In sum, the ultimate beneficiaries from improved financial market regulation are America’s workers, families and businesses—both small and large.”

But, said immediate past NYSSCPA Banking Committee chair Howard M. Gluckman, “Would these proposals have stopped the current mortgage and bond market confidence crisis? That is hard to say.”

Although the plan’s many proposals could be the source of congressional debate for years to come, Treasury officials have stated a desire for Congress to pass one particular provision that would establish a Mortgage Origination Commission (MOC), which would establish stricter, more uniform standards for lenders.

If the other provisions of the Treasury’s 200-page “Blueprint for a Modernized Financial Regulatory Structure” are accepted, the Office of Thrift Supervision (OTS)—one of the five agencies currently overseeing federal savings associations—would be completely eliminated, and the SEC would be merged with the Commodity Futures Trading Commission.

Although the Treasury said the “Blueprint” is not a response to recent economic upheaval and the Bear Stearns debacle, the plan is still being perceived by some as an attempt to fix the economy’s problems, according to the Washington Post.

Work on the “Blueprint” actually began a year ago, the Post said, and was intended to prevent such financial crises from occurring.

“It’s going to take many, many years to implement,” said Jeffrey Abramczyk, a member of the Society’s Stock Brokerage Committee. “It’s a complex animal.”

Abramczyk said he does believe reform is necessary, however, as the “wall between banker and dealer is being torn down.”

‘Blueprint’ Recommendations

The Mortgage Origination Commission

One short-term recommendation included in the “Blueprint”—and specially promoted by the Treasury—is the creation of the MOC, a new federal commission led by a presidential appointee that would evaluate the adequacy of each state’s system for licensing and regulating participants in the mortgage origination process, according to a Treasury “Blueprint” fact sheet.

“Most mortgage regulation over the past decades has been aimed at making sure that every ethnic, race or religious group had equal opportunity to get a mortgage,” Gluckman said. “Underwriting standards were pretty similar, but discrimination and cronyism was a problem. There wasn’t much concern that the mortgage industry would give mortgages to people who did not qualify from a business standpoint. That was an issue for mortgage bankers and investors that did not concern the government or public markets. 

“A major change occurred when the move to make mortgages more liquid by use of mortgage-backed securities and similar securitizations led to underwriting of mortgages that financial institutions would not grant due to higher-than-acceptable risk of default,” he continued. “The securities industry then divided these packages of mortgages into tranches by risk so that, theoretically, each buyer of a mortgage-backed security could invest in the level of risk and liquidity they could tolerate. It worked well and served all parties—buyers, investors, the securities industry and financial institutions.

What was not recognized, Gluckman said, was that the new system gave too many incentives to grant mortgages, and the prior regulatory thrust to promote granting of mortgages had no way to handle this situation. 

“A new Mortgage Origination Commission—together with state regulation of underwriting—may solve this problem if done properly,” he said. “There is, however, a risk of overreaction that will block granting of mortgages to some people who should qualify or to people to whom some risk takers might be willing to gamble.”

The President’s Working Group

The “modernization” of the existing President’s Working Group on Financial Markets, created in 1988 in response to events in the financial markets on “Black Monday” Oct. 19, 1987, would include changing the group’s executive order “to reinforce the mission of and purpose of the group as an ongoing mechanism for coordination and communication on financial policy matters including systemic risk, market integrity, investor and consumer protection and capital markets competitiveness,” according to the Treasury.

The recommendation, another short-term goal of the “Blueprint,” would also expand the President’s Working Group to include the Office of the Comptroller of the Currency, OTS and Federal Deposit Insurance Corporation.

Federal Reserve Lending

Liquidity provisioning by the Federal Reserve would expand access to Federal Reserve lending channels, and provide a framework for oversight of non-depository institutions, giving them temporary access to Federal Reserve credit while recognizing the differences between banks and non-banks, according to the Treasury, which included this as a short-term goal of the Blueprint.

Other Provisions

Intermediate recommendations, according to the Treasury, focus on eliminating some of the duplication in the existing regulatory system and offer ways to modernize the regulatory structure for certain financial services sectors within the current framework. In addition to eliminating the thrift charter, recommendations include creating an optional federal charter for insurance and unifying oversight for futures and securities.

Longer-term recommendations focus on creating an entirely new regulatory structure using “an objectives-based approach for optimal regulation,” the Treasury said.

The structure would consist of a market stability regulator, as well as a prudential regulator and a business conduct regulator, which both have a focus on consumer protection.

“We should and can have a structure that is designed for the world we live in, one that is more flexible, one that can better adapt to change, one that will allow us to more effectively deal with inevitable market disruptions and one that will better protect investors and consumers,” Paulson said in remarks to the Treasury Department. “The challenge is to evolve to a more flexible, efficient and effective regulatory framework—and that is the purpose of this ‘Blueprint.’”

The Federal Reserve as ‘Market Stability Regulator’

As “market stability regulator,” the Federal Reserve would have the responsibility and authority to gather information, disclose information, collaborate with the other regulators on rule writing, and take corrective actions when necessary to ensure overall financial market stability, according to the Treasury.

To fulfill its responsibilities to gather information, the Federal Reserve would have the authority to participate in examinations with prudential and business conduct regulators, the Treasury said.

This new role would replace the Federal Reserve’s more limited, traditional role as the supervisor of financial holding companies, bank holding companies, and certain state-chartered banks.

“To do this effectively, the Fed will collect information from commercial banks, investment banks, insurance companies, hedge funds, commodity pool operators,” Paulson said in remarks in Washington on March 31. “But rather than focus on the health of a particular organization, it will focus on whether a firm’s or industry’s practices threaten overall financial stability. It will have broad powers and the necessary corrective authorities to deal with deficiencies that pose threats to our financial stability.”

Some said the Federal Reserve pushed its jurisdiction to the brink in financing the Bear Stearns deal, but “they’ve only exercised that power only two or three times in recent history ... this is the first time they put taxpayer dollars up,” Abramczyk said.

The Current Financial Regulatory Structure

The functioning regulatory structure, according to the Treasury, “does not serve America as well as it could, and modernization is inevitable.”

The structure of the nation’s financial regulatory system has been largely “knit together” over the last 75 years, put into place for particular reasons at different times and in response to circumstances that may no longer exist, the Treasury said.

For example, Congress established the national bank charter in 1863 during the Civil War, the Federal Reserve System in 1913 in response to various episodes of financial instability, and the FDIC during the Great Depression. Changes were made to the regulatory structure in the intervening years in response to other financial crises, such as the thrift crises of the 1980s, or as enhancements like the Gramm-Leach-Bliley Act of 1999.

But for the most part, the Treasury said, “the underlying structure resembles what existed in the 1930s.”

The current U.S. regulatory framework for financial services providers includes:

“Capital markets and the financial services industry have evolved significantly over the past decade,” according to the Treasury, citing globalization trends and financial innovations such as securitization.

“These developments,” the Treasury said, “are pressuring the U.S. regulatory structure, exposing regulatory gaps and redundancies, and often encouraging market participants to do business in other jurisdictions with more effective regulation .... Although [the] Treasury began this effort a year ago, market conditions today provide a pertinent backdrop for this study’s release and highlight the need to examine the U.S. regulatory structure. Recent events have also reinforced the need to balance strong consumer protection and market stability on one hand, with capital markets competitiveness on the other.”

Existing Precedent

A precedent exists, at least in planning form, for a systemic change to the financial regulatory system. Both the Treasury and prior presidential administrations have noted similar goals, as early as 1984.

Gluckman pointed out that both 1984’s “Blueprint for Reform: The Report of the Task Group on Regulation of Financial Services” and “Modernizing the Financial System:

Recommendations for Safer, More Competitive Banks,” produced in 1991, laid the foundation for this and earlier actions.
But Gluckman said he agrees that the comprehensive plan is still a distant goal. “Wouldn’t it be great if the Fed could keep all financial markets stable? But how are they going to do that? This looks like a very long term project requiring research, inter-industry cooperation, federal and state coordination, testing of proposals, public hearings, congressional debates and a lot of politics,” he said. “It makes more sense to focus in on solving some of the more critical weaknesses that the [recent] crises uncovered, like failure of the independence of rating agencies, creation of new products without building adequate auditing and monitoring, and lack of responsibility by sellers of complex financial products without properly pointing out the liquidity and market risks to buyers.”

Melissa Hoffmann Lajara, Associate Editor, can be reached at mlajara@nysscpa.org.

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