Thursday, June 11, 2009

What Sort of Regulatory Reform to Expect

. Thursday, June 11, 2009

Tyler Cowen does not think that financial services will face many new regulations. I agree with some of his points, especially that nobody (other than Ron Paul) wants to see the Fed politicized any more than it has been. But I disagree with his overall tenor.

The Obama administration originally planned to combine different regulatory agencies into one or two bundles, in the style of the Department of Homeland Security (because that has worked so well). This was never very realistic. Many within and outside of the government would be nervous that too much power would be too concentrated in too few hands. Moreover, entrenched interests whose authority would be taken away will lobby to see their influence preserved.

So the administration has shifted focus to adding new regulations on top of the old in addition to a minor restructuring (rather than a complete overhaul) to the regulatory structure. This was always the most realistic outcome, and contra Cowen I think we will see some significant changes to the regulatory structure. I anticipate changes to at least several key areas:

1. Ratings agencies will have some kind of government oversight. Whether this comes in the form of a government "auditor" or a separate government ratings board, pure privatization of the ratings system is unlikely to continue. As part of this, securities issued by corporations and banks will be judged based on the quality of the contents rather than the reputation of the issuers. The goal will be to provide better risk assessments to potential buyers of these securities, especially institutional investors.

2. Financial firms will be prevented from "forum shopping" as described in this WaPo piece:

Under the current system, financial firms can choose among four regulators, some of whom receive funding from the companies. This arrangement has spurred agencies to compete for firms' business, sometimes by offering more lenient regulation.

3. Non-bank financial institutions that function as banks (e.g. Countrywide) will be regulated as banks.

And let's not forget that massive shifts that have already occurred, including the apparent ability of the Fed/Treasury to rule by fiat over almost any corporate action taken anywhere in America (if it is deemed to have sufficient systemic importance and/or affect a lot of union jobs). Surely these are not negligible.


What Sort of Regulatory Reform to Expect
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