Seismic Shift

Treasury Secretary Henry Paulson’s Blueprint for a massive overhaul of the financial services regulatory structure, which he unveiled March 31, is already sparking much debate among finance officials and lawmakers (Congress is planning to hold hearings on the Blueprint). The depth of the reaction to Paulson’s proposals, and the battle lines already being drawn, suggest that these are issues that will dominate discussion within and without the Beltway for a significant period of time. To help shape that discussion and influence the final form of the reform, advisors and their partners and their industry associations will need to not only understand Secretary Paulson’s proposals, but will need to have their voices heard during what is sure to be a drawn out process.

It’s likely to be a long process not only because of the scope of the proposed Blueprint but also considering Treasury’s past reform efforts, the most recent being the Gramm-Leach-Bliley Act of 1999–which brought down the Glass-Steagall Act and allowed banks to affiliate with securities firms. Treasury first recommended the Gramm-Leach-Bliley changes in the early to mid 1980s by a special commission in the Reagan Administration, recalls Duane Thompson, managing director of the Financial Planning Association’s (FPA) Washington office. So Treasury suggestions “like this [blueprint] tend to take 10 to 15 years, if at all,” to come about, warns Thompson. This reality, combined with the fact that there are only eight months left in the Bush Administration’s term, leaves little time to implement any significant changes.

Indeed, Paulson even acknowledged when releasing the Blueprint that the most urgent issues at hand are “working through this capital market turmoil and housing downturn,” and those will be the administration’s top priorities until they are resolved. “With few exceptions, the recommendations in this Blueprint should not and will not be implemented until after the present market difficulties are past,” Paulson said.

How long it will take for the capital markets and housing market to rebound is anyone’s guess. Federal Reserve Board Chairman Ben Bernanke told the Senate Banking Committee on April 3 that “financial markets remain under considerable stress,” and he has even uttered the word “recession” when talking about the current situation. Bernanke conceded in his testimony, however, that “monetary and fiscal policies are in train that should support a return to growth [in the U.S. economy] in the second half of this year and next year.” Bernanke defended the decision to rescue Bear Stearns from bankruptcy through a takeover by JPMorgan Chase and a $30 billion taxpayer loan during the April 3 hearing, arguing that a Bear Stearns meltdown would have had unpredictable and potentially disastrous consequences on the U.S. economy.

Members of Congress asked at the hearing whether a Fed rescue of this sort would set a precedent, and become standard practice if other investment banks were to teeter on the edge of financial ruin. Bernanke assured them that would not be the case, stating that the Bear Stearns situation was extraordinary and unique. Nevertheleless, Rep. Barney Frank (D-Massachusetts) is calling for legislation that would create a federal regulator for investment banks.

Blueprint Details

Treasury began the process leading to release of the Blueprint in March 2007, after holding a conference for industry leaders and policymakers on capital markets competitiveness. In his Blueprint, Paulson recommends short-, intermediate-, and long-term goals for regulatory reform, stating that the U.S. “should and can have a structure that is designed for the world we live in, one that is more flexible, one that can better adapt to change, one that will allow us to more effectively deal with inevitable market disruptions, and one that will better protect investors and consumers.”

In the short term, the Blueprint suggests creating a new federal commission for mortgage origination to better protect consumers, modernizing the President’s Working Group on Financial Markets, and clarifying the Federal Reserve’s liquidity provisioning. Intermediate goals include consolidating the Securities and Exchange Commission (SEC) and the U.S. Commodities Futures Trading Commission (CFTC), creating an SRO for investment advisors, eliminating the thrift charter, and creating an optional federal charter for insurance.

Long-term goals would create a Market Stability Regulator–which the Blueprint says would give the Federal Reserve the “ability to monitor risks across the financial system.” A Prudential Regulator would focus on safety and soundness of firms with federal guarantees, and a Business Conduct Regulator would focus on consumer protection. Business conduct regulation would include key aspects of consumer protection “such as disclosures, business practices, chartering and licensing of certain types of financial institutions, and rigorous enforcement programs,” Paulson said in releasing the Blueprint. “Having one agency responsible for these critically important issues for all financial products should bring greater consistency to regulation where overlapping requirements currently exist.”