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Business Costs & Regulation

A New Regulatory Regime for Banking

Watch for Congress to crack down on hedge funds and create a new watchdog agency. But the devil is in the details.

Can Washington effectively police Wall Street? More than a year after it started to reel from a series of high stakes bets that went from bad to worse, deepening the U.S. recession, the prescription for an effective fix remains elusive.

A regulatory overhaul is in the works. Congress will OK more consumer protections, including a watchdog agency to oversee credit cards, mortgages, auto and other direct consumer loans. But even though there’s broad consensus that the absence of smart regulation over Wall Street’s risk taking contributed to the crisis, there’s little agreement on what to do about it.

The fact is, limiting big risks to the system is a herculean task, requiring policymakers to develop a workable method of making Wall Street more accountable, and complex deals easier to track. And doing so without stifling the innovation needed to stimulate economic growth and compete in a global arena.

More oversight of Wall Street firms is a given: Large hedge funds and big private pools of capital will be forced to register with the Securities and Exchange Commission, for example. There’ll also be closer scrutiny of more kinds of derivatives, perhaps through a clearinghouse to ensure standardized contracts and open trading. Though it will slow financing deals, Congress won’t let these shadow banking firms continue to conduct their business out of sight of federal and state regulators.


But effectively guarding against system risk involves being a bit of a seer -- not reacting to yesterday’s crisis, but sussing out where tomorrow’s threat lurks. The regulators must anticipate and prevent a quake, not merely react once it has happened. And they’ve got to keep tabs on a huge amount of territory: not just big banks, but hedge funds, private equity groups, insurers -- in fact, any firm with a big financial role.

No candidate for the job has everyone’s confidence. Sen. Chris Dodd (D-CT), chairman of the Banking Committee, says the Federal Reserve isn’t up to the task, having failed to spot, much less ward off, the danger Wall Street courted in recent years. Others fret that Dodd’s idea of a council of regulators would get snarled in turf wars, ending up in gridlock. A leading alternative, supported by the influential chairman of the Federal Deposit Insurance Corporation, Sheila Bair: a tag team consisting of Treasury, which would finger troubled firms, and the FDIC, to usher them through restructuring.

Moreover, just deciding exactly who should be regulated is fraught with controversy. For example, Some House lawmakers want to exempt end users -- genuine hedgers who use derivative contracts to ensure against price, interest rate or other risks -- from a requirement that contracts be standardized. That’s a loophole that Barbara Roper, director of investor protection at the Consumer Federation of America, says is huge.

Also working against a solution: There’s not much political payoff. Most voters are baffled by the arcane workings of hedge funds, investment banks and exotic financial vehicles and don’t know how important they are to the economy. Plus the legislative timetable is short and the calendar more than full.


Voters do want to see Wall Street pay for the misery everyone is feeling, and lawmakers know they’ll take the rap if there’s another crisis like the last one. They’ll get kudos from voters if the package includes limits on executive pay and stiffer rules on credit cards. So look for a big push for a deal early in 2010. But whether the legislation will come close to setting up effective safeguards against quakes akin to those that shook the financial world for months starting last fall is very unclear.

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