[null, null, {"document_url": "https://www.barrons.com/articles/SB125391751717842265", "unformatted_src": "https://asset.barrons.com/public/resources/images/BA-AQ670_otherv_NS_20090925195643.jpg", "src": "https://asset.barrons.com/public/resources/images/BA-AQ670_otherv_NS_20090925195643.jpg", "formatted_filename": "BA AQ otherv NS", "alt_text": "Democratic Sen. Christopher Dodd wants the four U.S. banking agencies to merge, but that's unlikely to happen amid protests from bankers and regulators. In general, the government will tweak, rather than rethink, regulation, which may be a mistake."}, null]




AS RAHM EMANUEL, PRESIDENT Barack Obama's chief of staff, once said, "Never let a serious crisis go to waste."

But the current financial crisis won't be the catalyst to rethink fundamentally the structure of U.S. financial regulation. Instead, Congress will fill a few holes in the regulatory foundation, and install new radar for detecting systemic risk within the existing framework of regulation according to financial function or service. Unfortunately, in some cases, that's too little, too late. Democratic Sen. Christopher Dodd wants the four U.S. banking agencies to merge, but that's unlikely to happen amid protests from bankers and regulators. In general, the government will tweak, rather than rethink, regulation, which may be a mistake. Scott J. Ferrell/Congressional Quarterly

What shape is financial regulation likely to take? Let's examine what the government will do -- and what it should do -- with regard to major federal agencies and initiatives.

Securities and Exchange Commission

Congress will require most managers of hedge funds to register with the Securities and Exchange Commission, which would subject them to SEC inspections. But such registration wouldn't limit their investment strategies, or prevent them from charging clients high incentive fees.

However, the Treasury's effort to require registration of most managers of private-equity and venture-capital funds under the Investment Advisers Act isn't likely to pass. These funds aren't high-volume traders or short sellers that are likely to pose systemic risks.

The SEC will get the power to regulate all broker-dealers providing investment advice. According to Treasury, such brokers will owe a fiduciary-type duty to clients. The scope of this duty isn't defined yet, but it clearly goes beyond the vague "suitability" requirement.


The Treasury didn't propose a merger of the SEC and the Commodity Futures Trading Commission, despite a large overlap between financial futures and securities. The Treasury is avoiding the turf battle between the Senate Banking Committee, which oversees the SEC, and the Senate Agriculture Committee, which oversees the CFTC. A creative solution would be to establish a joint subcommittee to oversee a combined SEC and CFTC.

Congress will repeal the exceptions from commodities and securities laws for most off-exchange financial derivatives. But it will continue to allow nonstandardized futures contracts to be exempt from certain requirements. Customized contracts are important to many industrial companies, and the financial firms handling them will be subject to especially high capital requirements.

Congress will mandate that all standardized futures contracts be settled through a clearing corporation, which will require the relevant parties to post margin, marked to market daily, and ensure the completion of trades through a guaranty fund. Although regulators have approved three such clearing corporations, it would be more efficient to have one, as is the case for stocks.

Banking Agencies

Although Sen. Christopher Dodd of Connecticut is pushing for the merger of the four U.S. banking agencies -- the Federal Reserve, the Office of Thrift Supervision, the Federal Deposit Insurance Corporation and the Comptroller of the Currency -- into a single agency, that isn't likely to happen. On a policy basis, the four agencies already issue common rules on all significant topics. Politically, a merger will be strongly opposed by the banking industry and banking regulators.

Instead, Congress is likely to merge the Office of Thrift Supervision into the Comptroller of the Currency, creating one agency to regulate all nationally chartered banks and thrifts. The FDIC will continue to supervise small state-chartered banks, and the Fed will oversee large state-chartered banks.

The Treasury won't succeed in its efforts to prohibit all industrial companies from owning exempt banks, which had no role in the financial crisis. Exempt banks include credit-card banks and industrial-loan companies -- owned by companies such as General Electric and Target. A likely compromise: Grandfather all industrial companies that now own exempt banks, allowing them to retain the banking units.

Congress quietly extended from 2009 to 2013 the increase -- from $100,000 to $250,000 -- in the maximum size of bank deposits insured by the FDIC. This maximum probably will become permanent in 2013, although 98% of bank deposits are $100,000 or less.

Consumer Financial Protection Agency

As proposed by Treasury, the CFPA would have jurisdiction over all financial products offered to retail customers -- including savings products, credit cards, mortgage loans, custodial services and debt-collection services. At the last moment, Treasury deleted mutual funds and other securities regulated by the SEC.

The CFPA is likely to become the federal agency that regulates mortgage originations, which were poorly handled in the past by the Federal Reserve and the states. The CFPA also should regulate financial products and services provided primarily by nonbank lenders, especially to lower-income families, such as payday loans and debt-collection services.

However, Congress probably isn't going to supplant the jurisdiction of the banking agencies over bank deposits, fiduciary services and most loans. These agencies have publicly opposed the Treasury's proposal for the CFPA. One concern: Banks would then be subject to two sets of examinations on many products they offer to retail customers.

Systemic-Risk Regulator

The Treasury has proposed that a council of eight regulators become the monitor of systemic risk. This council would be an expanded version of the existing President's Working Group on Financial Markets. In addition, the Council would recommend the designation of certain firms as "systemically risky institutions [SRIs]," which would then make them regulated primarily by the Fed.

But group monitoring potentially would leave no one with responsibility. It would be better for the Fed to monitor risk because, in setting interest rates, it already follows closely developments in the financial markets and economy.

At the same time, Congress won't allow the Fed to be the primary regulator of SRIs because many politicians believe the Fed has too much power already. Moreover, it doesn't have the expertise to be the primary regulator of all nonbank SRIs, including insurance companies, money-market funds and hedge funds. Instead, the Fed should work together with the existing regulator of any nonbank SRI.

Congress is expected to authorize the FDIC to choose among multiple resolution alternatives, such as a bridge bank or conservator, in dealing with any SRI that becomes insolvent. The FDIC has more flexibility than the all-or-nothing approach of the bankruptcy code. Today, however, the FDIC only has jurisdiction over insolvent banks, not broker-dealers or even bank holding companies.

Insurance Regulation

As AIG's near-collapse illustrated, global life insurers can pose material risks to the financial system. But insurers are regulated by the states, not a federal agency. This approach imposes significant administrative costs on the insurance industry.

Life insurers have advocated the creation of an optional national insurance charter and federal regulator, much as the Comptroller of the Currency regulates national banks. While the states would oppose this, they would still supervise all property-casualty insurers and most life insurers.

The Treasury didn't propose a national life-insurance charter; instead, it suggested the establishment of an Office of National Insurance within the Treasury. This is a baby step in the right direction.

The proposed coverage of the new CFPA would encompass all "savings" products offered to retail consumers. This seems to include fixed annuities now regulated by the states, though it wouldn't extend to variable annuities constituting securities. The overlapping jurisdiction of the CFPA and the states in fixed annuities would result in conflict and confusion.

Later this year, Congress is likely to pass a "say on pay" statute requiring all public companies to hold an annual shareholder vote on the pay packages of top executives. While this vote will be advisory in nature, two other SEC rules will be legally binding.

The SEC recently endorsed an exchange rule prohibiting brokers from voting customer shares held in Street name on noncontested director elections without customer instructions. In the past, brokers almost always voted these shares -- without customer instructions -- for the company's slate of directors. In addition, the SEC has proposed a rule that would make it much easier for shareholders to nominate a few directors not on the company's slate. Some version of this rule will be adopted in time for the 2010 proxy season.

As a result of these two SEC rules and "say on pay" legislation, shareholders will have powerful new tools to influence the choice of directors and compensation of CEOs. While most institutional investors will be reluctant to initiate battles with public companies, aggressive hedge funds and activist public pensions won't.

In short, although many politicians initially called for a fundamental restructuring of financial regulation, legislative reforms will be more evolutionary than revolutionary. Despite lots of talk about streamlining, the number of financial agencies will remain exactly the same -- with the elimination of the Office of Thrift Supervision and the addition of the CFPA.

However, even without new legislation, financial regulators can increase capital requirements and decrease leverage at the institutions they supervise. These are the most critical changes needed to reduce the likelihood and severity of future financial crises. To make these changes effective, financial regulators should stop allowing large institutions to calculate their capital requirements based on their own internal risk models -- complex formulae often masking erroneous assumptions.

We need differential capital requirements based on objective risk measures, such as a mortgage's amount relative to the property's value. We also should require all large financial institutions to issue subordinated debt, which is bought by sophisticated investors. This combination would provide a good mix of regulatory and market oversight of large financial institutions.

ROBERT POZEN is chairman of MFS Investment Management and a senior lecturer at Harvard Business School. His book Too Big to Save? How to Fix the U.S. Financial System will be published in early November by John Wiley.

A Better Blueprint for Financial Regulation

AS RAHM EMANUEL, PRESIDENT Barack Obama's chief of staff, once said, &quot;Never let a serious crisis go to waste.


