Push Is on for Regulatory Overhaul
Lawmakers, Think Tanks Contemplate Sweeping Change

By Michael S. Rosenwald and David Cho
Washington Post Staff Writers
Thursday, October 16, 2008

As the nation's financial system continues to unravel, lawmakers on both sides of the aisle say the U.S. government appears poised to enact sweeping changes to the spider web of agencies that regulate banks and other financial firms.

There is no scarcity of ideas. From Capitol Hill come calls to eliminate some agencies altogether. There's the Treasury Department's "blueprint" for an overhaul, which lawmakers now say is far more pressing than when it was released in the spring. And from think tanks come 10-point plans with proposals that seemed pie-in-the-sky only months ago.

Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, plans to hold hearings on the matter in January. "The crisis has clearly accelerated things," he said.

Sen. Charles E. Schumer (D-N.Y.), who heads the Joint Economic Committee, said the momentum is toward creating a single agency to regulate banks of different stripes. "The idea of having a more unified, stronger, quieter regulator is almost certainly the direction in which we're going," he said. "There's been a lot of noise [from the regulators] and not much effectiveness."

The subprime mortgage meltdown and ensuing credit crisis revealed gaping holes in U.S. regulation, which has not kept up with the market's ever-evolving activities. Recent market inventions, including exotic mortgage securities and derivatives, have caused major financial firms to buckle and are threatening to sink the economy into a severe recession.

"I think we are going to get major regulatory reform," said Morris Goldstein, a senior fellow at the Peterson Institute for International Economics who is circulating his own 10-point plan on the Hill.

But some lawmakers and think tankers also stress that beyond a new regulatory structure, Congress needs to concentrate on specific rules. It needs to better understand how banks take risks and then rein them in.

Goldstein said, for one, there should be new rules addressing the liquidity of banks. The amount of liquid assets banks hold relative to total assets has gone way down in recent decades, because other forms of investment can provide a higher rate of return though they are more difficult to unwind in times of trouble, he said. In the current crisis, banks needed to borrow big sums of money to survive, but in some cases they couldn't.

Jerry Caprio, an economics professor at Williams College in Massachusetts and co-author of the book "Rethinking Banking Regulation," said the focus on golden parachutes and executive compensation is important but misses a larger problem in how employees of financial firms are rewarded. He said he would like to see Congress enact disclosure rules about how front-line traders are compensated for risk-taking. "It's the real risk-takers that you have to rein in," Caprio said.

And being in New England reminded him of another idea dating to the 19th century, when the bonuses of banking supervisors were deferred until it was clear how the gambles paid off. When the risk-taking proved too dangerous, the bonuses were reduced. Caprio noted that bonus reductions were rare. "You need to have a system where the market and supervisors are working as partners," he said.

Treasury's blueprint offers a foundation for the regulatory debate, lawmakers said. When Treasury Secretary Henry M. Paulson Jr. released the plan in April many lawmakers thought action on the plan was years away. Now it could be a matter of months. The blueprint proposes a reshaping of Wall Street and Washington's relationship, calling for the current patchwork of regulation to be scrapped in favor of fewer but more powerful regulators.

One of Treasury's ideas, called the prudential financial regulator, would regulate banks, which currently answer to five federal agencies. This new body would get rid of overlapping banking regulators, such as the Office of Thrift Supervision. A second major regulator would oversee consumer protection and business practices.

The Federal Reserve, meanwhile, would act as a "supercop" with broad powers to oversee nearly any part of the financial markets that it sees fit.

Some analysts and lawmakers have accused Treasury of trying to implement its vision of regulation on an ad hoc basis. For instance, the Fed is serving much of the "supercop" role that was defined in the blueprint with the encouragement of Treasury officials. They denied they were trying to implement the blueprint without Congressional authority.

At the time the blueprint was announced, some lawmakers, analysts and even regulators judged the plan too idealistic. John M. Reich, director of the Office of Thrift Supervision, appeared to dismiss the plan altogether. He told his employees in an e-mail that was obtained by The Washington Post: "When the Treasury Department issues its recommendations, expect to see news stories and renewed questions about what the future will hold. Take note of the fanfare, then look back to [past failed efforts to restructure financial regulation] and resume the important work that you continue to do so well."

OTS has been responsible for regulating thrifts, including the failed firms, Washington Mutual and IndyMac, and the troubled bank, Countrywide, which was bought by Bank of America.

Yesterday, while acknowledging a coming debate over regulatory structure, OTS Chief Operating Officer Scott Polakoff warned oversimplifying the regulatory structure. "Sometimes there is the risk of improving efficiency of a system but hindering effectiveness," he said.

Staff writer Binyamin Appelbaum contributed to this report.

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