Two years after the burst of the biggest financial bubble since the 1930s, the U.S. government has presented a plan to discipline the market and make banks less keen on taking risks. These regulations are designed to make the consumer and investor, as well as the entire economy, safer. In this particular case, “the entire economy” has the broadest sense of the word. Today, the entire world pays the price of the irresponsible acts committed by the American institutions. Those acts were easily permitted because of lenient legislation and errors in U.S. monetary policy. Thus, President Obama’s proposed innovations are welcome despite the delay. Such action of greater regulation of the financial sector could not have been expected from his predecessor, George W. Bush.
Some congressmen will resist the executive plan, seeing it as too controlling and harmful to the free market. Financial sector leaders will also likely try to stop the adoption of more severe controlled regulations of their businesses.
Major banks, aided by the government, are getting the necessary capital to normalize their operations more quickly than expected. Nine heavy weight institutions, including JP Morgan Chase, Morgan Stanley, and Goldman Sachs, announced on Wednesday their plan to repay the US$25 billion bailout they received from the U.S. Treasury. But will they accept government regulation if they can sustain themselves?
By presenting his plan, President Obama has tried to anticipate accusations of interventionism. The system, according to him, was operating on quicksand. President Obama emphasized that the proposed regulation should not limit creativity or innovation. It should only make the market stronger and more transparent in its operations and easier for the consumer to understand.
By mentioning the transparency and safety goals of the legislation, Obama touched on one of the system’s most defective areas. The bubble was created by a sequence of obscure operations, separate from accountability controls of the banks and incomprehensible to most people.
Essentially, there is not much originality in the changes proposed by the U.S. President. The plan includes a new scheme of institutional supervision with the creation of two institutions connected to the expansion of executive and Federal Reserve powers. The Fed will have authority over all significant institutions – banks or not – to provide stability to the system. Prior to this, it could only regulate commercial banks. It didn’t supervise other entities, like investment banks, which caused most of the disastrous operations. In Brazil, for instance, all of the financial system has been under federal control for several years now, and supervision of the Central Bank was already much stronger than that traditionally enforced by the U.S. Fed.
The plan also includes makes greater capital and liquidity demands of all kinds of institutions. Banks will have less freedom to give loans, if the measures are approved, and be forced to keep more cash reserves in the bank.
These kinds of limitations have been observed in Brazil for years. They are new to the American banking system because the U.S. was delayed in adopting the so-called Basel regulations, recommended by the Bank for International Settlements (BIS). It looks like a joke for Obama to ask the Basel Committee on Bank Supervision for stronger rules in the area of international loans.
One of the innovative improvements made by this program is the regulation of risk management agencies, which has been quite inefficient in preventing crises. One of the goals is to reduce conflicts of interest, such as when these agencies perform a service to clients subject to evaluation.
The plan’s details will be complicated and the Congress approval might be politically difficult. But the step is, overall, a positive change.