By Bob Dowling
(Caijing.com.cn) A man from Mars may have been surprised to see this headline in The Wall Street Journal on June 9: Financial Reforms Pared Back; White House to Preserve Regulators but Seek Tougher Rules, Avoiding a Political Battle.
Six days later, the Martian would have read in the same newspaper: "President Obama is expected Wednesday to propose the most sweeping reorganization of financial market supervision since the 1930s." And after another two days, this related headline would have caught the space alien's eye: Historic Overhaul of Finance Rules; New Plans for Oversight; Consumers, Shareholders, Hedge Funds, Home Buyers, Derivatives.
Foreign policy issues – such as the Iranian election backlash, wars in Iraq and Afghanistan, and North Korea's threatening nukes -- are still more serious for the White House than reforming Wall Street. But on the home front, preventing Wall Street from doing what it did to Americans and the rest of the world over the past two years has been given about as much priority as possible outside foreign policy. And after months of blaming "greedy" bankers for destroying the savings accounts of ordinary Americans, the Journal's latest headline on the subject might convince anyone from another planet that President Barack Obama has taken care not to disturb a single brick at the regulatory agencies that slept while Wall Street torched the world.
But the Martian might ask, "What does it all mean?" Only a month earlier, the White House appeared to have big plans to consolidate most of the regulatory agencies that let big financial institutions run amok. There was even talk of removing the Federal Reserve as a regulator for its failure to police big banks, while eliminating the Securities and Exchange Commission altogether and replacing it with a new, sharp-toothed super agency with broad powers to take on the heads of Wall Street firms.
All this was important not just for Americans but for the world, which was shocked by the loss of an estimated US$ 45 trillion in the subprime mortgage crisis. It's also important for migrant workers with jobs around the world who send money home to support families in developing countries -- a cash flow estimated at five times all international aid.
Instead of reforming the regulatory system, the Obama plan left regulators and their offices almost entirely unchanged. One, small savings institution regulator was eliminated, but otherwise Obama didn't budge a brick. SEC survived and the Fed gained considerably more power. A new agency to protect consumers was added in the 85-page plan, although every existing regulator already has a consumer division at its disposal.
So a head-scratching Martian could hardly be blamed for asking a few questions such as, "What happened? Did Obama cave in? Is Wall Street so powerful that it always wins? Is the president afraid of Wall Street, even after he offered it some US$ 2 trillion in financial support?
No one knows the answers yet. But a visitor from a distant planet could easily interpret the outcome as a cave-in.
Even the schedule of the reform plan is tame. The White House wants the Democrat-controlled Congress to pass the plan by the end of the year. That probably means if lawmakers, who are now being deluged by financial lobbyists, don't finish on time, no one will notice.
On paper, it sure looks like the president caved in. New York Times columnist Frank Rich says the move was "a punt," at least for the first round of reform. Here are some of the big questions ahead:
Regulatory behavior: Will new, tougher regulators be able to do a better job, even if they are running old agencies? Under the best of circumstances, it could take a few years to change the power structure and evaluate results. So Wall Street won time.
Monetary tools: Regulators would be encouraged to raise reserve requirements to slow leveraged lending, which was a big cause of the crisis. They could have asked the Fed to do this under the old system, but no one did. To coordinate themselves, regulators would work through a so-called Financial Services Oversight Council, a new layer added to five surviving agencies.
Hedge funds: Hedge funds along with private equity funds would be required to register and report some transactions, although questions remain over timing and thoroughness.
Derivatives: Before the crisis, most of these investment products were traded in the unregulated, unreported "shadow banking market." So many were shocked when AIG turned up with an exposure of US$ 465 billion in credit default swaps. The Obama plan says some derivatives should be reported through exchanges, but that customized derivatives would be exempt, leaving a potentially large loophole.
Credit rating agencies: Standard and Poor's, Moody's and Fitch -- the private companies that rated billions of mortgage securities Triple A before downgrading them to junk -- have been among the most criticized actors in the financial crisis. Without their high ratings, investment banks could not have sold securities around the world. Some in government wanted to nationalize or eliminate these raters. The Obama proposal, however, leaves them unaffected, except investors would be reminded that a rating should not be the only standard for an investment.
Too big to fail: There is no part of the plan, despite earlier proposals to break up big institutions such as Citibank and AIG, threatening the world financial system. Instead, they would face more Fed scrutiny to raise more high-grade capital. The Fed could have done this before the crisis, too, but didn't.
Obama may have decided to forego a major overhaul of the system for several reasons. These include:
Health care: Obama has made universal health care for Americans a main priority. And since any battle to regulate the financial industry would be long and bloody, the president might have worried that he would not get enough congressional votes for health care if he tried to push it through after a battle over financial regulation.
Money power: The financial industry is the largest, single donor of campaign funds to Washington politicians. Even though weakened, financial firms earlier this year muscled up US$ 28 million in lobbying funds to water down an accounting regulation they didn't like.
Exhausted voters: There is a bet in Washington that voters are getting worn out by Wall Street and the crisis. As long as stocks don't collapse and the U.S. housing market slowly improves, the politicians are probably right.
The latest reforms are a case study in how the Wall Street-Washington connection works, even under the weakest circumstances. A Martian, like the U.S. public, would be understandably confused. Polls show Americans still like Obama's speaking style. But they wonder whether words alone can protect their bank accounts.