With political pressure growing to do more to help struggling homeowners and address the crisis in the financial markets, the Bush Administration is moving forward with its attempt to define what promise to be extensive debates over how the government can lessen the pain and reduce the chances of a reoccurrence.
On Mar. 31, Treasury Secretary Henry Paulson laid out a wide-ranging plan to revamp the regulatory structure that governs banks, investment banks, and other financial-services firms. "First and foremost, we are working on getting through this period and minimizing the effect of the housing and capital markets on the economy," Paulson told BusinessWeek. "But at the same time, we also have the responsibility to look forward and say what are the best policies, and the best regulatory structure for the economy, and learn the lessons from events."
Simultaneously, there appears to be support for the first time within the Administration to help many homeowners who are "under water" on their mortgages—that is, they owe more money on their mortgages than their homes are currently worth. As first reported by The Washington Post, the Administration is working on a plan that would provide government-guaranteed insurance for new mortgages set at a lower value when lenders agree to reduce the principal to reflect the lower home value. Banks and other lenders would be encouraged to rework such loans and write off the difference, in exchange for government-backing behind the new, smaller mortgages.
Time to Step In
The moves come after months of criticism that the Administration has been moving too slow to address the housing and credit woes. Analysts say that the Administration may no longer have much choice, now that the government-backed firesale of Bear Stearns (BSC) has changed the political dynamic in Washington. Having offered up $29 billion of taxpayer money in that deal to prop up an investment bank, it is increasingly difficult to argue against broader help for homeowners proposed by Democrats in Congress and on the Presidential campaign trail. To regain leadership and exert influence over the debate, the Administration needed to get its own proposals on the table.
"The Administration's rhetoric has clearly shifted, and its proposals are becoming much more aggressive in terms of government action," says Daniel Clifton, a Washington policy analyst with the investment firm Strategas Research.
In prepared remarks he delivered while discussing details of the regulatory overhaul, Paulson said: "We have been undergoing a period of financial market stress since last August. Markets are repricing and reassessing risk and as we should expect, there are always difficulties during periods such as this.…As we work through this period, our highest priority is limiting its impact on the real economy."
While President Bush, Paulson and other top economic officials have repeatedly talked about the need to avoid doing more harm than good in the policy response to the crisis—and clearly implied that many Democratic measures would do just that—Clifton says they now have little choice but to shift gears. A key question, he says, has become "what's our alternative?" Clifton adds: "It may well be that the right position in reality is to avoid doing harm, but this is politics. They have to do something."
Streamlining and Stronger Oversight
The Adminstration's moves are widely seen as an attempt to set the minimal floor underneath the discussion of further policy moves—a useful first step, though just that.
In the case of the regulatory overhaul that Paulson announced, the first step is a wide-ranging proposal that would streamline and overhaul the system that has governed the financial-services industry since the aftermath of the Great Depression.
Paulson proposed a major consolidation of the various agencies that oversee the financial system. The Securities and Exchange Commission and the Commodity Futures Trading Commission, for instance, would be merged into one body. Over time, the plan—which has been in the works since March, 2007—foresees three primary regulators taking over that function from a patchwork of agencies that exist today.
Most important, Paulson is also proposing that the Federal Reserve be given stronger oversight powers over investment banks, hedge funds, and others, significantly expanding its ability to examine the books of such institutions when they borrow from the central bank. But the proposal also places a heavy emphasis on streamlining regulatory function and making it more efficient. Consumer advocates and others say that on first glance some of those proposals appear likely to weaken rather than strenghten regulation.
By setting the terms of the debate, however, the Administration hopes to head off more extensive measures being cooked up in Congress. Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, is currently working on proposals that would appear to give regulators more ability to force investment banks or others to raise their capital levels or reduce leverage than do the Treasury proposals. Both Frank and Senator Chris Dodd (D-Conn.) have proposed bills that would provide up to $400 billion in government guarantees for reworked mortgages if lenders agree to bring the principal value down to the currently appraised value of houses that are under water.
Analysts say that growing momentum for those plans—and the difficulty of continuing to fend off increased government aid for struggling homeowners when the government has invested tens of billions in rescuing the banking system—have clearly put pressure on the Administration. Much of that pressure is coming from congressional Republicans, says Clifton. With the approach of elections, the Republicans in Congress "know they must keep the ball rolling," he says. "This is really hurting all Republicans now because of the perceived inaction on the part of the Administration. They know they need to have proposals of their own; they can't just keep voting against Democratic bills."
Initial reaction to the Treasury's regulatory proposal was mixed. Some Democrats, especially those representing the corridors of financial power in New York, saw it as a positive starting point. "In broad outlines, we agree with large parts of Secretary Paulson's proposal," said Senator Charles Schumer (D-N.Y.) in a prepared statement.
But Democratic Presidential candidate Barack Obama told reporters the plan was "inadequate." The Illinois senator—who outlined his own proposals for regulatory reform in a speech a week earlier—said that while investment banks are now able to tap into the Federal Reserve's discount window for funds if they run into trouble, the Paulson plan would not require them to meet the stiffer requirements for capital reserves and liquidity levels required of commercial banks under Fed supervision.
"If they can have access to the Fed's discount window when in a crisis, that is a sacred insurance policy underwritten by the American people," says Austan Goolsbee, Obama's lead economic advisor. "If they can access that, then we must have government oversight and rules over what kind of behavior they can engage in" as the commercial banks have.
Paulson argues that the Fed has that oversight now, while the investment banks temporarily have access to the discount window; he adds that it is not a foregone conclusion that they will continue to benefit from such access. The Treasury proposal calls for further study of whether such access to the Fed backing should be made permanent for investment banks or other institutions that might now be granted it on a temporary basis; if it is made permanent, then heightened capital requirements and other standards that now apply to commercial banks would also be put in place.
But Goolsbee argues that the Fed has already opened the door to future emergency use of its lending window by investment banks, so greater oversight is needed before they get to a crisis point. He agrees that many parts of the Treasury proposal are a worthy starting point. Overall, though, he sees it as inadequate, part of a continuum in which the Administration has taken a minimalist approach to addressing the problems thrown up by the meltdown in the mortgage and credit markets. "They wait for the crisis to happen, then they react; they are doing something, but it's not enough," he says. The current proposals "would have done little to prevent the current crisis never mind to anticipate or prevent the next one."
A sure sign, if one was needed, that even as the Administration is stepping up its game, the political fight over how best to deal with the situation will continue.