Regulation issue

The financial regulatory reform plan formally announced by President Obama on Wednesday presents another challenge for a Congress already considering sweeping healthcare reform and climate change legislation.

Congress must enact reforms necessary to ward off another financial collapse, but also avoid burdensome regulations that could cut off innovation and wealth-creation on Wall Street. It must do this amid pressure from some of the most powerful and wealthy lobbies.

It’s a tough position for lawmakers, as members on both sides of the debate have some good arguments. Doing too little could cause a repeat of last fall’s nightmare, but doing too much also could cripple the economy.

Obama and his economic team have sought to stake out a starting point in the middle ground. Their proposal includes supervision of non-bank financial companies like AIG, which was at the heart of last fall’s crisis. They also want to create a systemic risk regulator to survey the entire financial landscape and identify problems that could bring down interconnected banks and other financial firms.

The proposal would eliminate the Office of Thrift Supervision (OTS) by merging it with another office. The OTS was widely seen as ineffective; it had jurisdiction over AIG, but a review of its top officials’ calendars by The Hill indicated that it held few meetings about the troubled insurer in the months before its collapse.

Obama’s caution is also reflected by what is not in the plan. His administration did not propose merging the Securities and Exchange Commission with the Commodity Futures Trading Commission, even though the current configuration splits jurisdiction over derivatives between two agencies and different congressional committees. The merger would have provoked huge battles within the administration and Congress.

Obama chose not to introduce new federal regulation over the insurance industry, which would have been another fight.

Despite this caution, the plan is filled with proposals that will draw serious opposition from a host of interests.

One of the biggest questions is the role of the Federal Reserve, which has seen its balance sheet and power grow during the crisis. Obama would strengthen it by giving it authority over non-bank financial giants and letting it fix banks’ capital requirements.

Lawmakers must ask questions about how much power the Fed should have. They must also address the fundamental question of how much protection and how much risk are appropriate for consumers purchasing financial products.

They must make sure those selling and packaging complicated securities bear risk appropriate to the capital on their balance sheets. They must avoid adding unnecessary and duplicative levels of regulation.