For nearly two years, the credit markets have been tightening, making it difficult for consumers and businesses to get credit for purchases and operations.  Several financial institutions declared bankruptcy or were on the brink of failure.  The federal government has used a variety of strategies to prevent a full-scale financial meltdown, including slashing interest rates, lending money to financial institutions, buying “toxic assets” and investing public monies in automobile companies.  This week, President Obama announced a second tactic to support the American economy:  preventing another banking crisis from occurring. 

It is an indisputable fact that one of the most significant contributors to our economic downturn was a unraveling of major financial institutions and the lack of adequate regulatory structures to prevent abuse and excess. A culture of irresponsibility took root from Wall Street to Washington to Main Street. And a regulatory regime basically crafted in the wake of a 20th century economic crisis — the Great Depression — was overwhelmed by the speed, scope, and sophistication of a 21st century global economy.

To read the entire remarks, click here. 

The plan proposes new regulation on financial firms and heightened protection of consumers with regard to purchase of financial products.  The Federal Reserve (“Fed“) will get significant new powers to regulate and oversee a wide variety of financial institutions, including stress tests of companies “too big to fail” like AIG and Lehman Brothers and regulation of parent companies and all subsidiaries, including unregulated units and those based overseas.

Executive pay and complex financial products will receive more scrutiny. 

A new agency to be called the Consumer Financial Protection Agency will have broad authority over consumer-oriented financial products, such as mortgages and credit cards. This agency would work with state regulators.

The Securities and Exchange Commission (“SEC”) would have broader powers to regulate hedge funds and venture capital funds. 

For a detailed summary of the plan, click on this Wall Street Journal Article. 

More details need to emerge before the plan can be adequately reviewed, but even the broad outline raises some questions:

• Is the SEC able to monitor/regulate hedge funds and venture capital funds?  Arguably, it did a poor job of catching the Bernie Madoff fraud. 
• What checks will be on the Fed’s power?  It is one of the least open and transparent agencies now. 
• Why does this proposal not restore some of the restrictions on banking contained in the repealed Glass-Steagall Act, which created the Federal Deposit Insurance Corporation (“FDIC”) and implemented a variety of checks on banks and financial institutions?

It is going to be very interesting to review this new regulatory scheme as the details emerge.  How do you feel about these changes?