Reforming the Financial System

On Monday, the one-year anniversary of the collapse of Lehman Brothers, President Obama is scheduled to deliver a major speech on the financial crisis. He should take justifiable pride in some of the aggressive steps his administration has taken to rescue the financial system and the broader economy.
Yet, the important work of regulatory reform remains undone. The administration has proposed legislation that would bring most of the financial system under a regulatory umbrella, and impose higher capital requirements to cushion against losses. But in specific areas, like consumer protection, Obama officials will have to fight to ensure that lawmakers do not water down the administration’s intent. In another area — the regulation of derivatives — Congress must improve the administration’s proposal. As Congress considers the legislation this fall, here are some key issues:
CONSUMER PROTECTION The financial crisis would have been less severe — or largely avoided — if regulators had curbed abusive and unsound lending back when bad mortgage loans first began to proliferate. But all too predictably, they failed to act.
Prominent overseers like the Federal Reserve and the Office of the Comptroller of the Currency had long viewed consumer protection as a regulatory backwater. In keeping with the prevailing antiregulatory ethos, they also tended to equate bank profitability with bank safety and soundness. That led them to view products and practices that boosted bank profits as “good”— even as tricky loans and lax lending standards set the stage for mass defaults, and systemwide collapse.
The strongest of the administration’s proposed reforms — a Consumer Financial Protection Agency — seeks to rectify that regulatory failure. The new agency would take on the consumer protection responsibilities that are currently dispersed among numerous regulators and police the financial system with a sole focus on the best interest of the consumer. It could ensure, for example, that lenders — whether banks or nonbanks — provide simpler alternatives to complex mortgages and could impose restrictions on other forms of credit, like stealth overdraft fees.
Unfortunately, Congress is already being pressured by the financial industry to weaken the proposal. It is imperative that the final legislation explicitly prohibit the new agency from pre-empting stronger state consumer-protection laws. Pre-emption— favored by banks, financial firms and regulators who are cozy with them — has long been used to reduce consumer protection and regulatory oversight. The final legislation must also retain the new agency’s power to examine banks’ books and enforce rules. An agency without full ongoing regulatory authority would be set up for failure.
DERIVATIVES The multitrillion-dollar market in derivatives was a major catalyst of the financial crisis. Derivatives are supposed to help investors and businesses manage risk, but after a 2000 law largely deregulated them, they also became tools for vast speculation, creating and amplifying risk instead of reducing it.
In general, the administration’s plan to regulate derivatives is serious and far-reaching. But, unfortunately, it is marred by loopholes that would protect banks’ lush profits in derivatives while leaving the system and taxpayers vulnerable to renewed instability.
The basic flaw in the plan is that it splits the derivatives market in two. Standardized derivative contracts would be traded on regulated exchanges. Customized contracts would continue to be privately traded — which could open the door to some of the same below-the-radar transactions that have already proved so disastrous. Beyond an odd contract here or there, derivatives should be standardized and exchange traded, period.
The administration’s proposed legislation also would exempt some derivative investors, like many hedge funds, from the requirement to trade standardized contracts on an exchange. This major exception could undermine the entire objective of lowering risk, increasing transparency and fostering efficiency.
That point was made in a recent letter to lawmakers from Gary Gensler, the chairman of the Commodity Futures Trading Commission, who would have significant responsibility for derivatives under a reformed system. Mr. Gensler has also pointed out that the proposed legislation would exempt certain derivatives called foreign exchange swaps from regulation. That broad exclusion could allow other derivatives transactions to be structured in a way that would avoid regulation.
A light touch on derivatives, when a firm hand is needed, only reinforces the notion that the banks are ultimately in charge. To restore confidence both in markets and in the government, Obama officials and lawmakers must tighten the derivatives reform proposal.
SYSTEMIC RISK REGULATION The administration proposes empowering the Federal Reserve to supervise and regulate firms whose failure could damage the system as a whole and to seize such firms if failure is imminent.
The proposal is clearly problematic. For one thing, the Fed, in its conduct of monetary policy, can itself be a source of systemic risk. It is widely believed that the Fed’s interest-rate decisions in this decade helped to inflate the housing bubble. In addition, the Fed, as currently configured, may not be sufficiently distanced from the banks to oversee the system objectively.
Unless the administration and the Fed propose policies and procedures to eliminate such conflicts, they are insurmountable. In that case, systemic risk regulation would best be left to a small group of bank regulators working to identify and resolve emerging risks.
Lost in this debate over the Fed’s role is the fact that systemic risk would best be controlled by restoring rules ignored in the deregulatory fervor of the past decade, developing new rules as needed and enforcing them day to day. Also missing from the debate — and the proposed legislation — is a roadmap for restructuring and downsizing too-big-to-fail institutions over time so that they are no longer a threat.
These changes will take time. For now, what is most important is that the broader reform effort get off the ground. Mr. Obama’s speech is the opportunity to relaunch the effort; the hard work still lies ahead.

Fonte: Jornal The New York Times