Government Proposes Financial System Fix-up

On Monday, Treasury Secretary Henry Paulson presented his blueprint to overhaul the way the U.S. regulates its financial system.   If implemented, the plan would significantly alter the way banks, brokerages and insurance companies conduct their business.  Some of the suggested changes would establish consistent licensing standards for mortgage lenders.  Another proposal, strongly opposed by the banking industry, may eliminate thrifts that once funded a major share of mortgage loans for new home buyers.   

Regulating the Financial System in Modern Times

The overhaul is needed, Paulson said, because “our  current regulatory structure was not built to address the modern financial system.”  Instead of creating a solid platform for regulation, we have “a pattern of creating regulators as a response to market innovations or market stress.”

In a nutshell, Paulson’s new model would shift more regulatory power to the federal government and away from the states.  In the long-term, federal financial regulation would be consolidated under three powerful agencies: the Federal Reserve, with expanded powers to act as “the market stability regulator;” one “prudential financial regulator ” to ensure the solidity and safety of federally chartered banks (instead of the five in place today); and a “conduct of business regulator,” somewhat like the Securities and Exchange Commission, that would oversee financial services firms.

Proposed changes under Paulson’s reorganization would:

• Form a federal commission to evaluate state mortgage regulation and establish federal standards for licensing and disclosure requirements for mortgage companies and mortgage brokers.

• Expand the Federal Reserve’s power to stabilize markets.  Extend its authority to review private capital pools, such as hedge funds.

• Convert thrifts into national banks to be regulated by the Comptroller of the Currency.  Eliminate the Office of Thrift Supervision and ultimately consolidate federal bank regulators.

• Offer insurance companies the choice to stay under state jurisdiction or to be regulated by the federal government under a new Office of National Insurance.

• Consolidate the Securities Exchange Commission and the Commodity Futures Trading Commission and eventually merge consumer protection and enforcement for financial services across the board.

Representative Barney Frank, D-Mass., commended Paulson for “rejecting the argument for the status quo” and bringing forward a plan.  The blueprint is a “contribution to a profound national discussion,” Frank said.

One proposed change is garnering strong support from both the ABA, the National Association of Mortgage Brokers (NAMB), the Mortgage Bankers Association (MBA) and other industry groups - establishing uniform national licensing standards for mortgage originators.  As it stands, states set and monitor their own set of standards without any consistent federal guidelines.  MBA Chairman Kieran Quinn stresses that needs to change. “One of the most significant problems for the mortgage industry and its customers is the explosive growth of inconsistent state regulations,” Quinn said.

Others were not so positive about some of the changes recommended in the plan.  One aspect that is proving to ruffle some feathers concerns the proposal to eliminate the thrift charter and convert thrifts to national banks.  The charter Congress established in 1933 was meant to serve as a conduit for savings account deposits to fund mortgage loans for home buyers.  But a report released by the Treasury Department shows that thrifts have lost a major share of the residential mortgage market to commercial banks, private issuers of mortgage-backed securities, and government-charted Freddie Mac and Fannie Mae. 

Edward Yingling, President of the American Bankers Association (ABA), takes issue with the suggestion that thrifts are no longer necessary.  “We are no more ready to abandon the thrift charter than we are to abandon the American family dream of living in a house that you own,” said Yingling, especially with more people seeking traditional mortgages to buy new homes. 

With so many powerful players and strong views on what should and should not be done to reform the financial regulatory system, one thing is for certain - it will be a long and arduous process!

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