The President’s Financial System Overhaul: It’s Time

Morris Segall      2009 economy, bailout, banking system, business landscape, economy, The new Fed actions

After a year of speculation and discussion, President Obama released his plan for reform and regulation of the nation’s financial system. There were few surprises. With more oversight and control centered in the Federal Reserve and augmented with newly created boards, the plan brings under new regulation and supervision virtually all major sectors and products of the financial services industry.

Born out of the cataclysmic financial losses of the current recession, the President’s plan seeks to avoid a repetition of the circumstances and events that led to the recent financial system meltdown. It is the quid pro quo for the federal government bailing out the U.S. credit system and nobody should be surprised at the far reaching reform and regulation embodied in the plan.

In the most sweeping regulation of the financial sector in this country since the Great Depression, it creates unprecedented power to seize banking institutions and intercede in the transaction systems in the financial marketplace. This would include the “breakup” of large financial conglomerates that pose a heightened risk to the functioning and integrity of the financial system.

Critics are bemoaning that the increased intrusion of the federal government in the affairs of the financial marketplace may cause restriction and higher costs of credit to borrowers. With all due respect, that has already occurred as a result of the massive debt losses sustained by the nation’s credit intermediaries and its investors and placement firms.

Like it or not the financial marketplace and its players are going to have to deal with more stringent governmental oversight and regulation to protect the country from another financial meltdown from insufficient credit risk underwriting.  The constriction of credit, the inability to conduct market transactions in asset backed securities and consumer and banking failures necessitate the comprehensive overhaul of the nation’s financial system.

The mandating of increased oversight of the nation’s banks including higher capital and liquidity standards and the assumption of prudent risk and the offering of high risk products will force the banking system to adopt a more stable lending and responsible posture. The regulation of credit card companies and mortgage brokers and other financial intermediaries serving consumers is required to also enforce higher standards of professional conduct, better risk underwriting and most of all, consumer protections from fraudulent and abusive practices.

Importantly, the overhaul plan includes regulation of the “paper” created around the asset based lending that leveraged and securitized these transactions and have been a major contributor to investor and lender losses as the value of such paper eroded more than the assets they backed and became illiquid.

Unfortunately, the President’s plan does not use this opportunity to streamline the regulatory system. We believe there are still too many agencies involved in the new regulatory framework and may lead to inefficiencies and inconsistencies in industry oversight. However, no new regulatory plan of this magnitude was going to be perfect and the overall benefits will outweigh the organizational faults. We also believe industry participants will adapt and operate successfully in the new environment and/or exit the more risky sectors of the financial marketplace. This will inure to the benefit of lenders and borrowers in providing a safer and fairer financial system.

The credit industry over the 2004-2007 period lost its way and its mistakes in the extension of credit to poor credit risks and the leveraging of those risks would have plunged us into a massive depression were it not for the Herculean federal rescue. It’s time we got this critical industry and system back under control.

Morris R. Segall, CFA, CIC