The financial blueprint

The administration's proposals embody a series of compromises, some more defensible than others--but at least (compare with health reform) the White House has worked out a careful, detailed plan and is making the case for it.

Most of the key elements are, or should be, uncontroversial: stronger system-wide oversight, albeit with responsibility divided between the Fed and a new Financial Services Oversight Council chaired by the Treasury; more demanding capital requirements for banks and other financial firms; an FDIC-like early resolution regime for systemically important financial institutions; new consumer protections, to be designed and enforced by a new agency; stronger regulation of securities, with a requirement that originators of securitised loans retain a material interest in the asset; and moves to get standardised derivatives traded on exchanges rather than over the counter. Based on recent experience, each of these proposals meets a clear need.

That is a lot to be getting on with, but it is disappointing nonetheless that Obama has flinched from attempting a thorough overhaul of the regulatory structure. The multiplicity of overlapping regulators not only remains, it grows more complicated. The Office of Thrift Supervision disappears into the Office of the Comptroller of the Currency, for a loss of one regulatory entity. But banks, for instance, will continue to regulated by many different state and federal regulators. In the end, opportunities for regulatory arbitrage will not be significantly reduced. There had been talk of merging the SEC and the CFTC as well, but that will not happen either.

A main reason for this timidity appears to be Congressional prerogatives--the unwillingness of various committees to surrender their oversight powers. This fracturing of supervision will put an enormous burden on the Treasury and its new oversight council. Next time, that is where the buck will stop.

The oversight council is a political compromise in another sense. It would have been tidier to put its functions at the Fed, now that the central bank is to have bigger systemic-stability responsibilities. But many in Congress think that the Fed is already too powerful, and is being rewarded for failure. So with one hand the administration gives it new authority (with respect to individual systemically significant banks and non-banks) and with the other denies it or takes it away (through the Treasury-led council; through the requirement to "receive prior written approval from the Treasury for emergency lending under its 'unusual and exigent circumstances' authority").

For the most part the plan is very good. If it can be implemented in this form--and depending on crucial details such as the precise form of the new capital requirements--the financial system will be safer. But the unmended complexity of the structure is going to be a serious problem. Getting the pieces to work well together will not be easy. And international co-ordination around the new rules, which the administration rightly wants to see improved, is going to be much more difficult than it should be. If getting domestic regulators to work together is going to be a challenge, I don't give much for the chances of effective  co-operation across borders.

Of the commentary I have read so far on the plan, I recommend this note by Douglas Elliott at Brookings.