Who's watching Wall Street as vote looms?

by Russ Wiles The Arizona Republic Apr. 23, 2010 04:51 PM

Reforming the nation's financial system has become the hot topic in Washington. Congressional Democrats have cobbled together more than 1,300 pages of proposals aimed at preventing another credit collapse like the 2008 trauma that triggered massive federal intervention and helped deepen the recession. The House and Senate have somewhat different proposals, although the focus is the same: keeping a closer watch on big banks to prevent the types of shocks that nearly brought down the system. Other proposals include better financial literacy for consumers, new oversight of executive pay, higher standards for bond-rating agencies and more illumination into the netherworld of hedge funds and derivatives. The legislation might help to stabilize the system, but it also promises extensive new government intervention in the marketplace, with more bureaucracy and uncertain costs. It has become a divisive partisan issue, with Democrats pointing to a vote next week, perhaps as early as Monday. Here are a few of the key proposals, with some last-minute changes considered likely.

• Reform proposal: Consumer protection. Congress could establish a Consumer Financial Protection Bureau, possibly at the Federal Reserve, with rulemaking powers and the ability to examine rules for banks, mortgage firms and others.

Arguments for: The idea is to coordinate federal consumer-protection efforts and react to problems quickly. The public could report problems on a hotline and receive guidance from an Office of Financial Literacy.

Arguments against: Myriad consumer-protection laws already are on the books and overseen by several banking and other financial regulators. Who's to say another layer of federal bureaucracy will help?

• Reform proposal: Large banks. The bills would strive to prevent costly bailouts in various ways. They would create an orderly process for federal regulators to liquidate big banks, could extend Fed oversight to big non-bank financial firms and could prohibit banks from certain trading and investing practices.

Arguments for: The acts aim to make big banks realize they aren't too large to fail, with the implication they shouldn't assume high risks that imperil the system. The bills would create a fund of $50 billion or more, built from fees on large financial firms, to help with liquidations and reduce the taxpayer impact.

Arguments against: Banks have failed for decades but usually not because of large size or complex holdings. Also, it remains to be seen whether Uncle Sam can devise an "orderly" way to liquidate big institutions. Plus, many innocent non-bank financial firms such as auto insurers might have to pay into the fund, too.

• Reform proposal: Systemic risk. Would create a Financial Stability Oversight Council to identify and monitor big-picture dangers that threaten the economy. It would be chaired by the Treasury Secretary, include members from other federal regulatory agencies and advise the Fed and other regulators.

Arguments for: The council would keep an eye on problematic firms and practices. It would make recommendations to the Fed and other regulators and could help bring big non-banks such as insurer AIG under Fed oversight. It also could approve Fed decisions to break up large, complex firms.

Arguments against: The council would employ an army of specialists to collect and analyze data and report on systemic risks. Yet the federal government already does a lot of this and didn't see the last crisis coming. And would the council point out systemic dangers caused by government policies?

• Reform proposal: Derivatives. These often risky financial instruments that place bets on all sorts of assets would come under more regulation. Much trading would be required on exchanges and central markets instead of private, unregulated dealings.

Arguments for: Bets on mortgage derivatives hastened the 2008 credit crunch. The bills aim to close loopholes on derivatives while imposing margin, or collateral, requirements on certain trades and improving transparency.

Arguments against: While illumination is clearly needed in this market, not all derivative trades are risky. Critics worry some restrictions could stifle innovation, impair Wall Street profits at a time when firms need to heal and hurt U.S. competitiveness.

• Reform proposal: Hedge funds. Large investment partnerships managing more than $100 million would need to register and disclose financial data to the Securities and Exchange Commission. State regulators would take over supervision of more non-hedge advisers.

Arguments for: Hedge funds seem to show up in every financial crisis, so it's reasonable to require them to provide more details on the often-big risks they undertake. The SEC currently can't examine the financial information of unregistered hedge funds.

Arguments against: The SEC is already considered overworked and underfunded. It missed the Madoff scandal and others. To ease its load, state regulators would oversee advisers with as much as $100 million in assets, up from $25 million now. But state regulators are strained, too.

• Reform proposal: Executive pay. The bills would give shareholders at public companies a non-binding say over executive compensation at public companies. They also would provide more guidance and standards to the corporate directors who set pay.

Arguments for: Executive rewards are often tied to risky practices. One intriguing proposal would force firms to take back executive pay if it's based on faulty company financial reports. Another would give the SEC more clout to open up director elections.

Arguments against: Executive pay is a tough issue to regulate. And despite popular uproar over Wall Street bonuses, shareholders often act more like sheep than lions, avoiding confrontations with management that could upset stock prices at their firms.

• Reform proposal: Credit-rating agencies. Debt-monitoring firms such as Moody's and Standard & Poor's would be subject to new SEC oversight, with the SEC authorized to hand out fines for poor performance.

Arguments for: These firms failed to give ratings that accurately reflected how risky mortgage debts were leading up to the housing meltdown. The act would add new disclosures, transparency tests and more.

Arguments against: While some changes are needed, the legislation doesn't seem to curtail the primary conflict of interest, whereby credit-rating agencies get paid by the same bond issuers that they evaluate.

Who's watching Wall Street as vote looms?