Lack of housing aid signals fight over regulatory reform

WASHINGTON – Treasury Secretary Henry M. Paulson Jr.’s blueprint for regulatory reform, officially unveiled Monday, sets the stage for a major confrontation with Congress by offering no relief for troubled homeowners and advocating what in many cases would be less, not more, federal supervision of the nation’s financial system.

Paulson proposed the broadest restructuring of federal regulatory institutions in 75 years with a call to merge agencies and redraw lines of authority that, in some cases, go back to the Great Depression.

But the plan would put off for years any attempt to create new regulations for the streamlined system to enforce. As a result, even if the new structure was eventually adopted, it would do little to prevent a repeat of the current crisis or something very much like it, Paulson acknowledged.

The gap between the Bush administration’s approach and what others are demanding drew immediate criticism from Democrats as well as some outside analysts.

“In a different time, the administration’s proposal would be a welcome start to a needed debate about modernizing the financial services regulatory system,” said Ellen Seidman of the New America Foundation, a centrist Washington think tank. “But this proposal does not deal with the root causes of our current crisis.”

Paulson said that upheavals have become a regular, if unfortunate, part of the financial system’s operation.

“I am not suggesting that more regulation is the answer or even that more effective regulation can prevent the periods of financial market stress that seem to occur every five to 10 years,” Paulson said Monday as he unveiled the 218-page plan.

House Speaker Nancy Pelosi, D-Calif., called Paulson’s plan a “step in the right direction” but said, “We need to go further.”

In a statement, Pelosi said, “We must take steps now to provide help to families who are hurting” because of mortgage foreclosures and job losses.

Paulson’s proposal reflects both the Bush administration’s aversion to government intervention in the economy and his own years on Wall Street.

“He’s taking advantage of the current crisis to push a regulatory restructuring plan that would otherwise attract no interest,” said Robert Litan, a senior fellow at the nonpartisan Brookings Institution in Washington.

Paulson, a former senior executive with investment giant Goldman Sachs Group Inc., described Washington’s regulatory apparatus as outmoded and outflanked by market innovations such as subprime mortgages and mortgage-backed securities.

Financial innovation is racing forward at such a feverish pace, he said, that the best the federal government can hope to do is set out the broad outlines of a system that can be altered as innovations, opportunities and threats emerge.

“We should and can have a structure that is designed for the world we live in, one that is more flexible, one that can better adapt to change,” he said.

Much of the nation’s regulatory apparatus is focused on making certain that traditional banks are run safely and soundly. But bankers have watched their importance diminish as financial players such as mortgage brokers, hedge funds, consumer-finance companies and others have taken bigger roles.

The current crisis started last summer when many subprime borrowers – those with less than perfect credit histories – began failing to make their monthly mortgage payments, raising doubts about the value of their mortgages and setting off a rash of foreclosures.

Similar doubts then cascaded throughout the financial system.

In his speech, Paulson singled out subprime mortgages as an example of an innovation that had benefited society. Among other things, he said, they provided people who previously had been denied credit the financing to buy homes.

But the new loans were outside the normal purview of Washington’s bank regulators, so the mortgages went almost unregulated until they had seeped into nearly every corner of the financial system in the form of mortgage-backed securities.

Paulson’s proposal envisions creating a new “Mortgage Origination Commission,” or MOC, that would include federal bank regulators and state officials. The MOC would propose licensing requirements for mortgage brokers and a method for revoking the licenses in cases of bad behavior.

But the MOC’s only clout would be the threat of giving those states that do not adopt the regulations a bad grade on a regularly issued report card.

“It was regulators’ mindless belief that the market is always right that made them deaf to warnings that the subprime market was trouble,” said Barbara Roper, investor protection director for the Consumer Federation of America. “Until you change that attitude and the reluctance to regulate, consumers and investors aren’t going to see any benefit.”

The administration faces a number of larger problems in pushing its plan.

First, the core of the plan was devised more than a year ago to reflect Paulson’s – and the president’s – conviction that the U.S. must lighten regulations on its financial industry or risk losing business to foreign financial centers such as London and Hong Kong.

But the proposal is being unveiled after the subprime mess, the housing meltdown and a drop in financial markets have left tens of millions of people poorer and more pessimistic, and the Democrat-controlled Congress in no mood to give financial firms more leeway.

“… (W)e must restore the trust and confidence of (American) investors and consumers,” Senate Banking Committee chairman Christopher Dodd, D-Conn., said in a statement. “That trust has been shattered – not because regulators did too much but because they did too little.”

Second, the plan has revived a series of spats between various interest groups that have scuttled previous financial regulatory restructuring proposals.

For example, the administration’s call to give insurance companies – overseen by state regulators for more than a century – the option of adopting a federal charter and being federally regulated has raised the hackles of state officials.

Officials in many states saw the overhaul plan as treading on their turf and said that, unless changed, they would fight it.

Similarly, the administration’s proposal to consolidate the Securities and Exchange Commission, which regulates most stocks, and the Commodity Futures Trading Commission, which regulates complex futures contracts, has provoked pointed objections from the agencies and chairmen of the congressional committees that oversee each.

Acting CFTC chairman Walter Lukken warned in a statement that combining the two agencies could “jeopardize” the CFTC’s “market expertise, manageable size, problem-solving culture and global outlook.”