CLARIFICATION AT BOTTOM
WASHINGTON — President Barack Obama's proposed overhaul of financial regulations aims to eliminate a number of the loopholes that contributed to the recession. Here's a summary of what went wrong and how his proposals would try to fix it:
- Nobody looking out for the little guy. At least five federal regulators had some responsibility for protecting consumers from fraud and predatory lending involving credit cards, payday loans, mortgages and other credit products. Yet this responsibility was the primary focus of none. Obama's plan would strip the Federal Reserve, Federal Trade Commission and other regulators of certain powers and give them to a newly created Consumer Financial Protection Agency. It would be independent and would have the power to make and enforce consumer-protection rules. States could pass rules even tougher than those of the new agency.
_ No regulator looking at the entire financial system. Individual regulators saw parts of the problem, but nobody saw how together they posed a systemic threat. The Federal Reserve would be charged with guarding against threats to the broad financial system. It would have until Oct. 1 to propose what new powers or changes in law it would need to do this.
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_ Insufficient regulatory tools. When investment bank Lehman Brothers went bust last September, regulators lacked the authority to seize it as they would a commercial bank. Its demise triggered a near-collapse of the global financial order. Obama's plan would allow regulators to take over and dissolve a large, globally interconnected financial institution if it posed a threat to the financial system.
_ Many voices, no consensus. Although at least seven federal regulators tried to halt the global financial slide, they spoke with different voices. Obama's plan would create a Financial Services Oversight Council — a panel of regulators led by the Treasury Department — to identify risks to the financial system and advise the Federal Reserve.
_ Outsized risks. Because no one was looking at the whole picture, regulators were unaware of how much risk had accumulated in the financial system. The Treasury Department will lead an effort to create new capital requirements for all financial institutions, not just banks, and must issue a report with proposed changes by Dec. 31. The Treasury is expected to require financial firms to save money in good times to have adequate reserves in bad times.
_ Shopping for the least regulation. Regulation of financial institutions was spread among several agencies whose enforcement can best be described as spotty. The most egregious example was insurer American International Group, which branched into financial products through a thrift that the Office of Thrift Supervision insufficiently regulated. That agency would disappear under Obama's plan, which would roll several federal regulators into a new National Bank Supervisor. It would govern all federally chartered lenders, whether they're banks or savings and loans.
_ Spreading risk without responsibility. The financial crisis began in mortgage finance, where mortgage brokers with no federal regulation originated loans that were underwritten mostly by investment banks that weren't regulated for their financial soundness. The banks bundled the loans into pools — a process called securitization — and the securities were sold to investors. Loan bundlers now would have to retain portions of what they sold to ensure that they too had "skin in the game."
_ Free rein for credit-rating agencies. Investors snapped up bundles of loans thinking that they were safe because rating agencies said they were. The rating agencies had a conflict of interest, however, because investment banks often hired them to package the loans. The Securities and Exchange Commission would get new powers to supervise rating agencies and demand tougher reporting requirements.
_ Investment banks ran amok. The SEC regulated investment banks only through the lens of investor protection. These banks — Bear Stearns, Lehman Brothers and others — often borrowed $30 to invest alongside every $1 of their own. The Obama plan would end SEC oversight of large global investment banks; the Federal Reserve would regulate them instead.
_ Hedge funds and other private pools of capital lacked transparency. These are investment funds for the very wealthy, trust funds, endowments and pension funds. They and private equity funds take huge risks in financial markets, but they aren't regulated. The absence of any public information about their finances amplified concerns as the global financial system tanked. Under Obama's plan they'd have to register and report to the SEC, which would determine whether their investments were so vast that their failure could pose a threat to the financial system.
_ Money market funds thought to be safe. These low-risk, low-return instruments earn interest for ordinary investors and were thought to be virtually risk free, until investors pulled so much money out of one last fall that its investment income fell below operating expenses. That added to the global financial panic. Obama's plan directs the President's Working Group on Financial Markets to recommend changes to eliminate the risk of runs on these funds.
_ Complex financial instruments exploded in popularity before they imploded. Over the past decade, these complex new products galloped beyond the reach of regulators. This was especially true of credit-default swaps, private bets between parties on the performances of loans or other forms of credit. This swaps market, which includes bets on the future prices of oil contracts, is valued in the trillions of dollars. Obama would subject it and other "derivatives" to comprehensive regulation and would require them to be traded on a regulated exchange, along with new reporting requirements and far greater transparency.
CLARIFICATION: A story about how President Barack Obama’s proposed overhaul of financial regulations aims to fix what went wrong with the industry said that insurer American International Group had branched into financial products through a thrift insufficiently regulated by the Office of Thrift Supervision. AIG operated a division involving financial products before the 2000 start of its thrift, which the OTS supervised. The exotic investments that brought down the company flourished after the thrift was formed and operated under OTS supervision, however.
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