President Obama said he was looking for a "careful balance" when sketching his blueprint to stabilize the nation's financial sector and wring from the system the kind of risky practices that propelled the country into economic turmoil.
But in seeking that balance — and bowing to political realities on Capitol Hill — the president may have boxed himself in with a mixed-bag proposal that has managed to disappoint economists and financial experts across the spectrum.
"Is he proposing a system with smarter regulation, or just more regulation?" asked Martin Baily, a senior fellow in economic studies at the liberal Brookings Institution and chair of the Council of Economic Advisers for the Clinton Administration, who was adopting a wait-and-see attitude about how the details of the plan play out.
The plan that Obama rolled out Wednesday would expand government oversight of banks and other financial institutions, establish a new consumer financial protection agency, and more vigorously regulate both financial markets and unusual financial instruments like credit derivatives.
But rather than setting the parameters of a broad shake-up of the nation's financial regulation system, the proposal has emerged a muddle, says R. Christopher Whalen of Institutional Risk Analytics.
"The plan is not doing a whole lot of anything," says Whalen, a former Wall Street investment banker. "The fundamental point is that we don't need new tools; we need political will to clean up the mess."
Resistance To Broadening Fed's Role
Advocates of Obama's plan characterize it as a good first step, but acknowledge that the turf battles he faces on Capitol Hill — where Congress has to approve the plan — will kill off some of his proposals.
One that's already considered in deep trouble is Obama's recommendation that the Federal Reserve be given new powers and expanded authority to supervise firms at risk.
"That's going to be a struggle between the president and Congress," Baily says. "Congress wants to see the Fed's power reined in."
After the Fed's controversial bailout of insurance giant AIG, that's true on both sides of the aisle: In an interview Wednesday on MSNBC, Virginia Democratic Sen. Mark Warner said he is concerned that giving the Fed more power will compromise its independence and "draw it further into the political process."
James Gattuso, a senior research fellow in regulatory policy at the conservative Heritage Foundation, agrees.
"The more power given to the Fed, the more political it becomes," Gattuso says. He suggested that accountability would emerge as an issue on the Fed's Board of Governors, whose members are appointed for terms of 14 years.
"This goes straight to the dilemma between accountability and politics," Gattuso says. "If the Fed is going to intervene to support an individual company, do you want that decision made by an unaccountable body?"
Will Innovation Be Stifled?
Critics like Gattuso and David Kotok, co-founder of the money management firm Cumberland Advisors, suggest that Obama's move to use more regulation to manage risk in the financial markets will stifle innovation.
Kotok suggested that the move to impose new regulations — while maintaining a structure to bail out large, interconnected firms whose failure could trigger a domino effect — smacks of "social democracy."
At its core, Obama's proposal is about handling risk. But Gattuso says the overarching theme of the plan is to limit risk through regulation, instead of allowing risk to be borne by those who take it.
Still, after the financial fiasco of last fall, which saw the failure of AIG and Lehman Brothers, there remain strong voices in favor of managing systemic risk with new oversight and regulation.
"A key positive" of Obama's plan, says Douglas Elliott, an economist at Brookings, is its "focus on systemic risk."
"There's been a tendency to focus on each institution," he says," rather than broader trends."
Having new oversight will "help — and help with coordination with regulators."
What's Missing?
When asked what's missing from the administration's plan, economists all have suggestions.
Gattuso wanted to see a proposal to liquidate Freddie Mac and Fannie Mae, the two giant government-sponsored mortgage finance lenders that were enmeshed in the subprime mortgage crisis.
"I'd like to see their abolition — tarred, feathered and sent on their way," he said.
Whalen said that Obama failed to provide a plan to fix securitization markets, and predicted that the president in a few months will have to come up with a new plan when a historic wave of foreclosed homes is expected to hit the market.
And Elliott expressed disappointment that Obama's promise to streamline the regulatory system failed to materialize.
There was, he said, "only the most modest of consolidation of regulatory functions." Obama proposed eliminating only one financial regulatory agency, the Office of Thrift Supervision — which was dying quite well on its own.
"I don't think there's anyone who can defend the current system with a straight face," Elliott said.
Consumer Plan Vague
Part of Obama's proposal has built-in public appeal: the creation of a Consumer Financial Protection Agency. The administration says the agency would not only enforce existing laws, but write new ones to help protect consumers from, for example, predatory lenders and unscrupulous credit card companies.
But there is some skepticism about what exactly the agency would do, and some dismissed it as a public relations tool.
"[It] can be helpful," says Elliott, "but it needs to find the best way to protect consumers while allowing healthy innovation."
The bottom-line question: Could last fall's financial meltdown have been prevented if Obama's proposals had been in effect?
Unlikely, says Whalen, whose criticism of the shortcomings of Obama's plan runs directly to Lawrence Summers, the director of the president's National Economic Council.
Summers' strategy is to "basically do nothing," Whalen says, and sell the notion of "continuity and confidence."
"He wants to wait until [the financial picture] gets better," Whalen says of Summers.
And it's not going to any time soon, Whalen predicted.
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