In Times of Crisis, Regulation Stirs

In the wake of the credit and housing crises, U.S. leaders are reconsidering decades of deregulation, and working on new rules for Wall Street.

The developed global economy is based on investors' willingness to gamble on the future. The system is based on the assumption that investment risk and potential reward go hand-in-hand.

In restructuring regulation, the challenge will be reducing risk enough to assure investors that the odds aren't stacked against them, without also eliminating the potential rewards that justify placing a bet at all.

Existing regulations

At least four federal agencies - the Federal Reserve Bank (Fed), the Federal Deposit Insurance Commission (FDIC), the Office of the Comptroller of the Currency and the Office of Thrift Supervision- all have some jurisdiction over mortgage lending. And state regulators had jurisdiction over the many non-bank mortgage lenders that accounted for about 40 percent of new subprime loans before that market collapsed in August 2007. U.S. regulation of insurance is solely at the state level.

Wall Street firms vs. commercial banks

To make matters even more complicated, the non-bank mortgage lenders that financed many of the high-risk loans aren't held to the same standards as the bank on the corner where you make your deposit.

Commercial banks submit to greater regulation, partly in exchange for the privilege of being able to borrow from the Federal Reserve.

The Glass-Steagall Banking Act of 1933 separated commercial banks from investment banking activities and created FDIC to insure people's deposits. The Gramm-Leach-Bliley Act of 1999 created financial holding companies and made the SEC their regulator instead of the Fed.

Wall Street firms played a major role in the mortgage crisis, packaging and financing trillions of dollars in high-risk home mortgages. The losses resulting from those mortgages have pushed the economy towards recession.

But starting the last week of March 2008, Wall Street firms got a bailout from the Fed without subjecting themselves to additional regulation. Congress says its time to change that.

But there is little agreement about what sort of new regulations are needed, and how much regulation. Some fear that shortening the leash could dry up investment money when the economy needs it most. Others argue that Wall Street firms like Goldman Sachs and Merrill Lynch should be treated just like commercial banks.

Proposals Revaluate Role of Regulation

Massachusetts Representative Barney Frank (D) is in favor of creating a new government regulator to oversee all financial markets and to intervene when necessary. Frank says another solution would be giving the Federal Reserve greater powers over Wall Street. 

Business advocacy groups like the American Council for Capital Formation worry that new regulations could stifle the free market. The Bush Administration agrees.

The debate represents philosophical differences about government regulation. The philosophy that regulation safeguards investors vs. the philosophy that regulation hurts the market.

Treasury officials say the regulatory system is out of date and disjointed. For example, the United States is one of the only countries in the world that separates traditional stocks and bonds (securities) from the contracts that require the delivery of stocks or bonds at a specified price and on a specified future date (futures).

Treasury Secretary Henry Paulson calls for additional oversight by the Fed, specifically more public disclosure and more formal cooperation between Fed, SEC, & Commodity Futures Trading Commission. However Paulson cautions against over-moderating risk and assisting speculators who are willing to walk away from their mortgages when they are worth more than the value of the house.

The Treasury plans to release a blueprint for a regulatory overhaul of the financial system in the near future which is also expected to address the proper oversight of banks and non-banks.

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