Regulatory Overhaul Moving Directly to the Back Burner

WASHINGTON — Treasury Secretary Henry Paulson on Monday outlined the biggest overhaul of U.S. financial regulation since the Great Depression, and won some support from Democratic leaders in Congress.

But they harshly condemned his timing, saying it would divert attention from the far more pressing need to help homeowners avoid foreclosure.

"I would call this a wild pitch. It's not even close to the strike zone," Senate Banking Committee Chairman Christopher Dodd, D-Conn., told reporters shortly after Paulson unveiled his plan. While Treasury is promoting long-term regulatory reform, millions of Americans are falling behind in mortgage payments, and "the problem is growing worse by the hour," he said.

"To talk about overhauling the regulatory system is a wonderful idea," Dodd said. But "why bring this up today?"

Senate Majority Leader Harry Reid, D-Nev., during the same teleconference, told reporters he would force a vote Tuesday on his Foreclosure Prevention Act to keep the focus on the housing crisis.

"We're concerned about today," Reid said. "We feel the White House should direct its attention to what needs to be done now."

Last month, Senate Republicans used procedural maneuvers to block progress of the bill aimed at helping 600,000 families avoid foreclosure. The legislation would allow judges to help homeowners in Chapter 13 bankruptcy proceedings by cutting their interest rates, extending payments or even lowering principle to make mortgage payments more affordable.

Lenders are fiercely opposed, but Reid said "we need to do something" because as many as 2 million families may face foreclosures this year.

In announcing his "transformative" reform of the regulatory system, Paulson himself conceded that implementation would "require a great deal of discussion and many years to complete." Most of the changes would require approval of Congress or state governments.

Paulson's 212-page blueprint would transform financial regulation in three phases:

— In the short term, the President's Working Group, an interagency panel that crafted the administration's first response to the credit crisis, would be beefed up and given more oversight responsibility. A new federal commission would be created to review how states regulate mortgages, and the Federal Reserve's responsibilities for extending aid to financial institutions would be clarified.

— In the intermediate term, several agencies — including the Securities and Exchange Commission, the Commodity Futures Trading Commission, and the Office of Thrift Supervision — would be merged or reorganized to provide a clearer, stronger regulatory structure.

— In the long term, the Federal Reserve would be given additional powers as a "market stability regulator" to ensure stability across the financial sector. In addition, a "prudential regulator" would oversee firms that receive federal financial guarantees, and a "business conduct regulator" would monitor business practices of financial firms.

Still, Paulson acknowledged that the housing problems come first. "We will not seek to implement (the reforms) on a pace or in a manner that interferes with our first priority of working through this current period of market difficulty," he said.

When asked whether President Bush believes the entire package could pass before his term ends in January, White House spokeswoman Dana Perino told reporters that "I think we'll have to see. ... It's a big attempt."

The Federal Reserve emerges in the Paulson blueprint as a more powerful body with wider responsibilities for safeguarding the overall financial system.

The Fed already has been moving in that direction, allowing Wall Street investment banks to use its "discount window," where retail banks traditionally have gotten cheap financing. The Fed also agreed last month to finance nearly $30 billion in Bear Stearns' assets to help rescue the crumbling Wall Street firm.

Paulson said the central bank should "have the authority to go wherever in the system it thinks it needs to go for a deeper look to preserve stability." He also wants to streamline the responsibilities of federal regulators, and initiate greater oversight of state-level regulations for mortgage brokers.

His plan generally won support from business groups. For example, John Castellani, president of the Business Roundtable, an association of chief executive officers, issued a statement praising the effort "to modernize and improve a patchwork of outdated and overlapping regulations."

But many experts on financial regulations said Paulson's plans would not fix the mortgage crunch, or prevent new ones. "It does little to constrain the banks and securities from the kinds of abuses that gave rise to the current crisis," Peter Morici, an economics professor at the University of Maryland, said in a written assessment. "Nor does his plan provide adequate safeguard to avoid future credit crises and recessions from a recurrence of securitization abuses," he said.

The nation's housing crisis began more than two years ago when many of the subprime mortgages made during the housing market bubble of 2002-2005, started running into trouble. Those loans, made to people with irregular income or weak credit histories, typically had low initial payments before rising to far higher interest rates. Many home buyers found they could not afford the higher payments, and the cooling real estate market kept them from selling or refinancing.

In recent years, subprime and other mortgages typically have been "bundled" into securities. Doubts about the value of those securities rose as homeowners fell behind on payments, meaning that mortgage brokers, lenders, regulators and Wall Street investors all have played a role in the wider credit crunch.

THE PAULSON PLAN

The Treasury secretary's words and what they mean

What the plan is: "A blueprint for financial regulatory structure that would be more effective and more appropriate for modern financial markets."

Significance: Wall Street has long been frustrated by what it sees as a complex and confusing system of financial regulation, and under Secretary Paulson, they are getting the reform they seek.

What the plan is not: "Some may view these recommendations as a response to the circumstances of the day; yet, that is not how they are intended."

Significance: Paulson pointed out in his speech that a presidential panel issued recommendations last month for dealing with the national credit crisis, and that his new regulation plan is not intended to interfere with those measures.

When it will take effect: "The recommendations in this blueprint should not and will not be implemented until after the present market difficulties are past."

Significance: Both the current Congress and the Bush administration are in their final months. With housing problems causing severe pain as the election approaches, most observers expect them to focus on that issue and let the next president and Congress deal with the Paulson plan, or something like it.

A VISION OF THE REGULATORY FUTURE

In addition to short- and medium-term regulatory changes, in the long run the Treasury Department wants to create three distinct regulators of financial institutions.

MARKET STABILITY REGULATOR

The Federal Reserve would monitor risks across the financial system, not just involving banks and holding companies. It would have broader powers to collect and disclose information, collaborate with the other regulators on rule writing, and take corrective actions when necessary to ensure overall market stability.

PRUDENTIAL REGULATOR

This regulator would focus on the safety and soundness of individual firms that benefit from explicit federal guarantees. It would be empowered to enforce capital adequacy requirements, investment limits and activity limits, and could conduct on-site risk management supervision.

BUSINESS CONDUCT REGULATOR

This regulator would oversee key aspects of consumer protection such as writing rules for disclosures and business practices, and the chartering and licensing of certain types of financial firms.