by GCM

Created on: April 04, 2008   Last Updated: February 11, 2009

Initial Thoughts on Paulson's Proposed Regulatory Reform of the U.S. Financial System

Treasury Secretary Paulson has proposed a three step process to reform the financial regulatory system. He claims that his proposal is aimed to help give tools to financial regulators to prevent or respond to future crises. Endnote 1. His three steps are as follows:

In the first step, the current system of financial regulation remains the same. However, a federal Mortgage Origination Commission would be created to set minimum licensing standards and to grade the adequacy of each state's system of mortgage licensing. In the second step, would entail: (1) consolidating the office of thrift charter with comptroller of the currency which oversees nationally chartered banks; (2) providing federal oversight of state chartered banks; (3) giving the Federal Reserve oversight over the payment and settlement system for transferring securities; (4) creating a federal agency to oversee insurance; and (5) merge the Commodities Futures Trading Commission (CFTC) and the Securities Exchange Commission (SEC). In the third step, five separate regulators would emerge: (a) the Federal Reserve would watch for threats to the stability of the financial system and would have theoretical power to intervene "to address current risks and restrain risk taking, but only when the overall financial stability is threaten; (b) a Prudential Financial Regulatory Agency would regulate all lenders that have explicit government guarantees; (c) a Conduct of Business Regulatory Agency would handle consumer protection across all financial firms (d) a Federal Insurance Guarantee Corp. would handles deposit insurance; and (e) a Corporate Finance Regulator would take over corporate disclosures, governance, and accounting issues. See Endnote 2.

In reviewing the proposal, at least three questions should probably be asked. 1) Does it respond to the causes of the current crisis? 2) Does it provide for any other potential benefits? 3) What are the plan's potential drawbacks?

Does this Proposal Respond to the Causes of the Current Crisis?

Paulson's proposal should be measured by how will it responds and prevents the causes of the current crisis. Those causes in the most simplistic terms were a combination of two things: (1) lax regulation of banks and mortgage brokers that allowed them to extend credit to homebuyers who were not credit worthy; and (2) without sufficient regulatory oversight, banks, investment houses like Bear

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