By Binyamin Appelbaum and David Cho
Washington Post Staff Writers
Wednesday, June 17, 2009
The Obama administration last night detailed a series of proposals to involve the government more deeply in private markets, from helping to steer borrowers into affordable mortgage loans to imposing new limits on the largest financial companies, in a sweeping effort to curb the kinds of reckless risk-taking that sparked the economic crisis.
The plan seeks to overhaul the nation's outdated system of financial regulations. Senior officials debated using a bulldozer to clear the way for fundamental reforms but decided instead to build within the shell of the existing system, offering what amounts to an architect's blueprint for modernizing a creaky old building.
The White House makes its case for this approach in an 85-page white paper that describes the roots of the crisis. Gaps in regulation allowed companies to make loans many borrowers could not afford. Funding came from new kinds of investments that were poorly understood by regulators. Big firms paid employees massive bonuses, while setting aside little money to absorb potential losses.
"While this crisis had many causes, it is clear now that the government could have done more to prevent many of these problems from growing out of control and threatening the stability of our financial system," the white paper says.
The plan is built around five key points, according to a briefing last night by senior administration officials and a copy of the white paper obtained by The Washington Post.
The proposals would greatly increase the power of the Federal Reserve, creating stronger and more consistent oversight of the largest financial firms.
It also asks Congress to authorize the government for the first time to dismantle large firms that fall into trouble, avoiding a chaotic collapse that could disrupt the economy.
Federal oversight would be extended to dark corners of the financial markets, imposing new rules on trading in complex derivatives and securities built from mortgage loans.
The government would create a new agency to protect consumers of mortgages, credit cards and other financial products.
And the administration would increase its coordination with other nations to prevent businesses from migrating to less regulated venues.
President Obama is scheduled to announce the full plan today, ending months of political calibration and internal discussion and dropping the details into an already-heated debate on Capitol Hill. Congress is scheduled to hold its first hearings on the proposals tomorrow, and interest groups already are ramping up their campaigns. Congressional leaders say they hope to pass some version of the plan by year's end.
"Speed is important," Obama said yesterday in an interview aired by CNBC. "We want to do it right. We want to do it carefully. But we don't want to tilt at windmills. We want to make sure that we're getting the best possible regulatory framework in place so that we're not repeating the mistakes of the past."
The administration already has hammered out a number of compromises with key Democrats in Congress, in hopes of creating a proposal that can survive the challenge from competing interests such as hedge funds hoping to avoid regulation and consumer groups seeking even greater protections. But while the proposals sharpen the discussion about reform, they don't end it.
"With their proposals today, the administration has moved this critical debate from broad discussion to specific action," said Timothy Ryan of the Securities Industry and Financial Markets Association.
The administration's plan leans heavily on the Fed, expanding its role as the regulator of the nation's largest banks such as J.P. Morgan Chase and Goldman Sachs to include other giant financial firms, such as the insurance companies American International Group and MetLife. The agency, which has greater independence from the political process than other regulators, would have broad authority to impose special requirements on those companies, such as mandating that they set aside a larger percentage of their assets against possible losses than smaller firms. Such a requirement could limit large companies' appetite for risk, but also their profit and growth.
The plan calls for a council of regulators to consult with the Fed, including the Treasury secretary and the heads of the other financial regulatory agencies: The Securities and Exchange Commission, Commodity Futures Trading Commission, the Federal Housing Finance Agency and the agencies that regulate banks. A primary task of the council would be to recommend which large, globally interconnected firms are too big to fail and should be subject to more rigorous oversight. But the council will not have the authority to oppose decisions made by the central bank.
Agencies other than the Fed pressed for the creation of such a council, but its limited role is likely to disappoint them. Prominent Democrats and Republicans in Congress also have signaled that they are reluctant to increase the Fed's powers without imposing stronger limitations.
A second element likely to provoke fierce debate is the establishment of a Consumer Financial Protection Agency.
The agency would have broad authority to overhaul a tangled mess of federal regulations, such as the various laws that compel lenders to give mortgage borrowers a massive stack of paperwork at closing that includes several calculations of the true cost of the loan itself.
"Consumers should have clear disclosure regarding the consequences of their financial decisions," the plan states.
The agency also would have the authority to change the way that loans are sold. One idea highlighted by the administration is to require that lenders offer all customers standard "plain vanilla" loans, such as 30-year, fixed-rate mortgages with streamlined pricing. The sale of loans with more complicated terms would be subjected to greater scrutiny by the agency. It could even require that customers who take more complicated loans sign a waiver.
And the agency would have a mandate to increase the availability of financial products in lower-income communities and other underserved areas, in part by enforcing the Community Reinvestment Act, which requires banks to make loans everywhere that they collect deposits.
To carry out these responsibilities, the agency would be granted the same powers as the regulators charged with keeping banks healthy, including the ability to write rules, conduct examinations, and impose fines and other penalties.
Regulatory agencies and industry groups acknowledge failures in recent years. But they say the existing model remains the best way to protect consumers, arguing that the agencies can identify problems more easily because of their close engagement with firms. They also are concerned that a consumer agency could be overly restrictive, limiting access to loans and constraining the development of new types of accounts, loans and other financial services.
"This consumer protection agency would be deciding how people get to live as opposed to people getting to decide for themselves," said Kelly King, chief executive of BB&T, a large commercial bank based in North Carolina.
Consumer advocates say the current financial crisis is ample evidence of the need for a new approach.
"We've tried it the other way for years, and obviously it didn't work. That's how we got here," said John Taylor of the National Community Reinvestment Coalition.
Several ideas have been dropped as the administration picks its battles. The plan will not include a new way of regulating insurance companies at the federal level. The insurance industry, which is regulated at the state level, is deeply divided, and the White House anticipated a distracting fight. The administration instead plans to create an office in the Treasury Department to monitor the insurance industry.
Some of the largest insurance companies could still fall under the scrutiny of the Federal Reserve in its new role as a systemic risk regulator.
The administration had earlier backed away from a proposal to merge the two agencies that oversee financial markets, and to merge the four agencies that regulate banks. It still will seek to merge the Office of Thrift Supervision and the Office of the Comptroller of the Currency to create a single agency to oversee banks with national charters. It also will propose eliminating the regulatory category for thrifts, traditionally defined as banks that focus on mortgage lending.
Steve Adamske, spokesman for the House Financial Services Committee, said committee Chairman Rep. Barney Frank (D-Mass.) plans to launch hearings on the specific proposals next week, and to hold votes on pieces of the legislation as soon as July.
"We've been waiting for this for a long time," Adamske said.
The Senate is not expected to begin work on the reforms until fall.
Staff writers Brady Dennis and Zachary A. Goldfarb contributed to this report.