We knew this was coming.
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Once the cowboys of Wall Street gave up their maverick status by converting from investment banks to regulated bank-holding companies and accepted government handouts, they were toast.
Today, President Obama is set to unveil the biggest overhaul of financial industry regulations since the Great Depression.
The debate over the details of his plan will be heated. In the end, Congress will bend to the public pressure that is demanding the government take steps to prevent history from repeating itself.
Under the plan, the government would have new powers to seize key companies — such as insurance giant American International Group Inc. whose failure jeopardizes the financial system. Currently, the government's authority to commandeer companies is mostly limited to banks.
Most analysts agree that the lack of transparency in conjunction with unchecked leverage were the main culprits that brought the system down.
Greasing the Government’s Path
New government rules proposed by the administration would give regulators greater access to the books of the nation’s financial firms. Along with the FDIC, the Federal Reserve also will be given broader authority over firms that are “too big to fail.”
The President’s proposals additionally may require that the financial firms that churn out derivatives and mortgage-backed securities have more skin in the game.
Without the type of government oversight now being proposed, failed investment banks like Bear Stearns and Lehman Brothers were able to leverage huge deals by only risking fractions of their assets.
These firms were like the thousands of sub-prime borrowers who only put up 5 percent instead of the usual 20 percent down payment to buy a home. In the end, when it was time to pay the piper, they simply didn’t have adequate reserves to cover their losses because there was no margin for error.
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President Obama’s regulatory revamping is also likely to force firms that package and market financial instruments, like mortgage-backed securities, to have an actual stake in the products they are selling.
Critics of the current system charge that financial firms were able to rate and sell securities — now labeled toxic — with impunity because once sold, they were off the hook if the investments went south.
Theoretically, the sellers of these securities would be more circumspect if they were at-risk alongside their investors. As a result, institutions that originate loans may be required to retain up to 5 percent of the credit risk when their loans are turned into securities.
Regulating Credit Cards
In response to popular pressure, the administration is expected to propose the creation of a regulatory body for financial products marketed to consumers, such as credit cards, whose current oversight is now spread over several agencies. On the table will be ceilings on credit card interest rates, bank fees and elimination of the practice known universal default.
Universal default allows banks issuing credit cards to jack up interest rates when their customers are delinquent in any of their payments even if a consumer is not specifically late on the payment of his or her bill. While changes in a consumer’s credit-worthiness may ultimately lead to higher interest rates, the President’s proposal would create a watchdog agency to assure that consumers are protected from hikes that amount to usury.
Too Much Government Muscle?
Even before the ink is dry on the administration’s plan, credit card companies are warning that such changes will stifle free access to consumer credit. In their own defense, they argue that the current system allows them to keep credit flowing because they can continuously adjust the risk.
Other early opponents of the President’s plan are concerned that such regulations ultimately may lead to the government having too much authority over the free market of consumer interest rates and limit the types of investment products that are available in the financial marketplace. While the President’s detractors admit some changes to the system are needed, they charge that Obama’s proposals ultimately will stymie risk and undermine financial creativity.
Predictably, on the other side of the aisle, the President’s supporters are applauding his bold willingness to take on the entrenched special interests of the financial industry. Not surprisingly, some in the President’s own party are lamenting that Obama’s proposals are too little, too late.
Historically, after every financial crisis, the regulatory pendulum swings the other way. It happened after the savings and loan crisis in the ‘80s and following the insider trading scandals that plagued Wall Street in the early ‘90s.
As we have seen time and again, once the crisis abates and the sting of loss begins to fade, so, too, will the fervor regulate every aspect of the financial market.
John Cohn is a senior partner in the Globe West Financial Group, based in West Los Angeles. He may be contacted at www.globewestfinancial.com
