President Obama revealed his plans for restructuring the US financial regulatory system last week. The broad principles and priorities of the plan were already known, courtesy of an article by Timothy Geithner and Lawrence Summers, two of its main architects, in the Washington Post, a couple of weeks ago. Now the proposals are on the table and, from the initial responses, a tough fight in Congress awaits them. After the events of the past year, during which the excesses of the financial system and the threat they posed to the global economy were so vivid, there cannot be any support for maintaining the status quo. However, any plan to change the system will inevitably have greater impact on some components of the system than on others, and that is where the resistance is bound to come.
From an objective standpoint, the plan is quite consciously balanced between the need to preserve and encourage the creative power of market forces and the need to rein them in. Consequently, while there is resistance brewing against many of the specific proposals, there is also some scepticism about their effectiveness. There need not be. Ultimately, the test of the plan will be in its execution. Meanwhile, it is important to remember that the fundamental principles that govern financial regulation and which formed the bedrock of the US system that was set up after the crash of 1929 — transparency and prudence — remain as critical as ever. It was the absence of these attributes in many of the new directions in which financial services ventured in recent times that resulted in the meltdown. That basic lesson has not been lost sight of in the Obama plan which, quite logically, is premised on the need to extend the application of these principles in a meaningful way across the entire spectrum of financial activity.
An important component of the plan, for example, is a consumer protection agency for financial products and services, whose mandate will be to find and enforce ways to simplify communication to individual consumers and the nature of contracts between them and financial institutions. This would truly be a leap forward in transparency, without any accompanying increase in the costs of doing business. On the prudential front, the most significant advance is the recognition of systemic risks, particularly the threat that large, diversified financial conglomerates pose to the entire financial system. An integrated view of their exposures and linkages and appropriate prudential measures based on it directly addresses the lacuna that became evident in the collapse or near-collapse of several of these institutions. The logic of extending transparency and prudential requirements to every segment of the financial sector supports the non-disruptive approach that the Obama administration has chosen to take. The true measure of its appropriateness may well be the resistance from both sides.
