While Questions Remain, Obama Regulatory Reforms Get a Solid B+

The Obama administration today proposed sweeping changes to the way financial services enterprises are regulated. If enacted, the changes would most likely be the most extensive in recent memory.

But equally interesting are the changes that still have yet to be hashed out. They portend a major lobbying battle on Capitol Hill.

Reserve Requirements

The most significant question yet to be determined is just how much capital financial institutions will be required to reserve. In a way, all the other proposals – however admirable – pale in comparison to this question. Whether are not the Office of Thrift Supervision survives matters little to bank balance sheets; capital reserves matter most acutely. The president’s white paper on reform actually offers little clues about how much capital will be required in the report on the matter due by year’s end.

Fannie, Freddie & the FHLB

Basically, the federal government still doesn’t know what to do with its problem step-sisters, Fannie Mae, Freddie Mac and the Federal Home Loan Bank. The white paper says that the Department of the “Treasury and the Department of Housing and Urban Development, in consultation with other government agencies, will engage in a wide-ranging initiative to develop recommendations on the future of Fannie Mae and Freddie Mac, and the Federal Home Loan Bank system. We need to maintain the continued stability and strength of the GSEs during these difficult financial times.” These government agencies will make a recommendation “at the time of the President’s 2011 Budget release.” We could not confirm exactly when that will be.

Compensation

The white paper proposes “that federal regulators issue standards for compensation practices by banks and bank holding companies.” Few guidelines were offered. Here’s what the white paper says:

Federal regulators should issue standards and guidelines to better align executive compensation practices of financial firms with long-term shareholder value and to prevent compensation practices from providing incentives that could threaten the safety and soundness of supervised institutions. In addition, we will support legislation requiring all public companies to hold non-binding shareholder resolutions on the compensation packages of senior executive officers, as well as new requirements to make compensation committees more independent.

No deadline was given for issuance of these “standards for compensation practices.”

How the Fed Will Do It

Much new powers are being given to the Federal Reserve, but it is unclear how the Fed will implement them. The Fed has until Oct. 1 to propose recommendations for how it will “better align its structure and governance with its authorities and responsibilities.” Put it another, the Fed has to figure out how to do what the president wants it to do.

Overall Assessment

While these big questions remain about the proposed regulatory changes, there is much to commend in the white paper. From my perspective, just the creation of the Financial Services Oversight Council will deserve great rejoicing from those who believe systemic risk must be controlled. (I am in that crew.)

As presented, the National Bank Supervisor appears as though it could be an ingenious way to allow for the micro regulation of particular banks being undertaken today, while preventing banks from falling through the cracks or shopping regulators. It also has the potential to eventually fold all the regulatory bodies under one auspice.

Overall, I’d give the reforms as proposed a B+, with points taken off for the to-be-figured-out components. Clearly, the Obama administration wants to fix the nation’s regulatory infrastructure and put much thought into how to go about fixing it.