New rules put Fed in hot seat - S&P cuts credit ratings on 22 banks/Financial regulation becomes art

New rules put Fed in hot seat - S&P cuts credit ratings on 22 banks
By Krishna Guha and Tom Braithwaite in Washington
Copyright The Financial Times Limited 2009
Published: June 16 2009 20:39 | Last updated: June 17 2009 15:01
http://www.ft.com/cms/s/0/36b5409e-5aaa-11de-8c14-00144feabdc0.html


President Barack Obama will reveal plans on Wednesday for a new system of US financial regulation that expands the powers of the Federal Reserve so that it can assume primary responsibility for averting financial crises.

Mr Obama will also announce plans for the creation of a council of financial regulators, intended to improve co-ordination between different agencies. The council will discuss systemic risks but the Fed will not need its approval to act against them.

The president will also announce plans to create a new Consumer Financial Protection Agency and call for the elimination of the Office of Thrift Supervision, a bank regulator.

However, the administration has decided not to consolidate more regulators due to the political difficulties involved. Instead, Mr Obama will propose rule changes to limit jurisdiction-shopping by companies.

Mr Obama will signal tougher capital requirements - particularly for the most important banks - and move to strengthen the infrastructure of core markets.The president also aims to curb excessive risk-taking through reform of securitisation markets and changes to compensation practices - including "say on pay" for shareholders and a regulatory effort to assess risks induced by compensation policies.

He will propose giving the Federal Deposit Insurance Corporation special resolution powers to wind down complex financial institutions, which policymakers hope will mitigate the moral hazard created by recent bail-outs.

"We have tried to identify the set of issues that are most crucial," Lawrence Summers, Mr Obama's top economic adviser, told the Financial Times. "This goes to having a systemic view, to generally raising capital levels, to the resolution regime, to consumers, to strengthening markets, to making sure people do not choose their regulator causing there to be a race to the bottom."

The Fed will be charged with looking at risks to the system as a whole, with a focus on core banks and markets. It will retain direct supervision of the largest bank holding companies - something the Bush administration had proposed taking away. The Fed will also directly supervisenon-bank financial companies that reach a similar size or complexity, and is likely to have the final word on bank capital requirements.

The emphasis on the Fed is controversial in Congress, where some critics fault the Fed for not exerting its regulatory powers more vigorously in the run-up to the crisis and others worry about the implications for Fed independence. Mark Warner, a Democratic senator, told the FT that systemic risk authority should be vested in the council of regulators instead.

Mr Summers defended the decision to give the Fed the lead on systemic risk. "In order to rely on responsibility being exercised you do need to have enough authority to ensure accountability," he said. "Leaving it all to a committee or a council would not be very effective. It would lack agility and accountability."

Fed chairman Ben Bernanke believes that systemic risk powers - also known as "macroprudential" powers - may allow a central bank to limit credit and asset price bubbles not easily addressed with interest rates. But some Fed officials worry that the exercise of systemic risk powers will entangle it in political fights.

The prospect of increased regulation was one of the factors in the decision by S&P to cut its credit rating on 22 banks on Wednesday, saying: “We believe the banking industry is undergoing a structural transformation that may include radical changes with permanent repercussions.”

This sent banking shares tumbling. Wells Fargo, which was cut by one notch to AA-, lost 3.9 per cent to $23.45, while Fifth Third, which S&P cut by two notches to BBB, dropped 8.4 per cent to $6.58.




Financial regulation becomes art
By Edward Luce in Washington
Copyright The Financial Times Limited 2009
Published: June 17 2009 17:33 | Last updated: June 17 2009 17:33
http://www.ft.com/cms/s/0/dc454a6c-5b5a-11de-be3f-00144feabdc0.html


Six months ago some observers were predicting the return in some form of the Glass-Steagall act, whose abolition in 1999 broke down the walls between investment banks and their stodgier deposit-taking cousins. Its disappearance has been blamed for some of the excesses that led to the current financial crisis.

Wednesday’s financial white paper, which was the fruit of months of scrambled consultation between the Obama administration and industry players, represents the art of what is politically possible. There was no hint of a return to a two-tiered banking system which some, including Paul Volcker, an adviser to Barack Obama and former chairman of the Federal Reserve, had recommended.

Nor was there any trace of the original plan to produce a drastic consolidation of banking regulators. Instead of six banking regulators, there will now be five – the Office of Thrift Supervision being the sacrificial lamb. But in their place, there will be a new consumer products regulator and a council of supervisors to oversee the Federal Reserve’s new role as the systemic risk regulator.

As Mr Obama said on Tuesday: “We want to do it right. We want to do it carefully. But we don’t want to tilt at windmills.” The result is a skilfully threaded series of compromises between a diverse galaxy of regulators, Capitol Hill barons and industry lobby groups. How much of it will survive its passage through Congress remains an open question.

Certainly, most of the financial sector lobby community is happy with what has emerged. “The Treasury department consulted very widely and has produced a careful and balanced proposal,” says Scott Talbott, vice-president of the Financial Services Forum, a Wall Street lobby group.

Perhaps the most vulnerable element of Wednesday’s overhaul is the proposal to give the Fed new powers over institutions that are too big to fail. Given that the Fed is held responsible for stoking the asset bubble in the first place, many lawmakers, including Democrats, see this is as the regulatory equivalent of rewarding failure. They point to the Fed’s role in creating easy money over the past few years and then failing to save Lehman Brothers at what is dated as the beginning of the meltdown last September.

“I share the concern that there are tensions between the Federal Reserve’s responsibilities for the conduct of monetary policy and its responsibilities for bank supervision,” said Mark Warner, the Democratic senator for Virginia, who sits on the Senate banking committee. “Too much economic power in one place puts our system of government at risk. Our Founding Fathers opposed concentrations of power, economic or otherwise, and favoured a system of check and balances.”

Republicans are even more strident in their opposition to a more powerful Fed. “The vast expansion of the Fed’s balance sheet in recent months arguably represents a far more significant source of “systemic risk” to our nation’s economy than the failure of any specific financial institution,” said the Republican congressional leadership in a recent statement.

Observers predict that Capitol Hill could end up giving the new Financial Services Oversight Council a greater role – possibly even a veto – at the expense of the Fed. Beyond that, most of the battles will be fought over detail rather than regulatory design.

The chairmen of the leading committees on Capitol Hill are broadly happy with the retention of the fragmented regulatory system. “The downside of retaining the regulatory architecture is that banks will retain a lot of scope to pursue regulatory arbitrage so they can find the agency with the lightest touch,” says Douglas Elliott, a former investment banker now at the Brookings Institution.

The large banks, however, are likely to lobby furiously against the administration’s proposal to levy higher capital adequacy and prudential requirements on them. “The fact that the details were not spelt out will give the big institutions scope to water it down,” said Mr Elliott.

Banks will also try to dilute the powers of the new Consumer Financial Protection Agency, which is likely to take supervision of mortgages away from the Fed, while the Securities and Exchange Commission will retain oversight of mutual funds. However, opponents recognise it will be hard to get rid of the CFPA altogether. “There is a lot of political support for a new consumer protection agency,” said Mr Talbott.