The Pursuit of Financial Stability in the Obama Era

By Guest Contributor Fabrice Coles

When President Obama took office, he pledged to lead the United States out of the economic doldrums that had befallen it. When he took the oath of office, over three million jobs had been lost in the previous year, banks had ceased to lend to families and small businesses, and economic uncertainty hung over the nation like a heavy rain cloud. Now that a little more than a year has passed since his inauguration, it is possible to perform an objective assessment of the impact to date of the Administration’s proposals.

Within one month of his inauguration, President Obama’s choice for Treasury Secretary, Timothy Geithner, presented the Administration’s plan for stabilizing the financial system. The financial stability plan was intended to build upon the Emergency Economic Stabilization Act of 2008 (the “Bailout”) which established the Troubled Asset Relief Program (TARP). The stability plan focused on improving the capital base of banks to remove fear of bank failure from the marketplace. Secretary Geithner announced that the government would conduct “stress tests” on the largest and most interconnected financial firms as well as enact programs intended to restart markets for consumer credit which had been frozen since the onset of the crisis. These measures would be pursued concurrently in order to make a robust push towards normality. The government concluded the stress tests in May, resulting in many financial firms raising capital in order to prepare for possible future losses. The programs enacted to stabilize consumer credit markets are largely viewed as having been a success, as market participants have come back to the credit markets. Once the government started to implement the financial stability plan, the Treasury concurrently turned its attention to drafting its plan for rewriting financial regulatory rules.

A number of factors contributed to the financial crisis. The central bank maintained a low interest rate for a sustained period of time. Some Federal government regulators did not perform sufficient oversight over financial institutions and market participants. Consumers made financial decisions that have resulted in problems arising with mortgages and credit cards. Financial institutions took advantage of a low interest rate environment and light touch regulation to leverage proprietary investments in securities based on sub-prime mortgages. These securities were sold around the world and large complex financial institutions held onto them. These institutions were often tied to commercial lending operations, and the eventual losses on the mortgage investments would end up in a restriction of credit by these entities to families and small businesses.

In mid-June, the Obama Administration released its white paper laying out how it planned to respond to the regulatory gaps that contributed to the crisis. The white paper, titled “Financial Regulatory Reform: A New Foundation”, contained the Treasury’s policy principles for responding to the varied assortment of inputs which contributed to the most severe financial crisis since the great depression. The Administration proposed reforms centered around the following objectives: 1) Promoting robust supervision and regulation of financial firms; 2) establishing comprehensive supervision of financial markets; 3) protecting consumers and investors from financial abuse; 4) providing the government with the tools it needs to manage financial crises and 5) raising international regulatory standards and improving international cooperation.

The House Financial Services and Senate Banking Committees spent the rest of 2009 focused on legislation that largely reflected the Administration’s principles. Many hearings, markups and negotiations later, the House was the first to act. In December, the House of Representatives passed HR 4173, the Wall Street Reform and Consumer Protection Act of 2009. The bill, passed largely along party lines, looked a great deal like the Obama proposal, save some normal legislative concessions. Senator Chris Dodd, the Senate Banking Committee Chairman, introduced a draft Bill in November, in hopes of reporting a bill to the whole Senate soon after. Within hours of the draft bill’s introduction, however, the Chairman’s draft faced heavy opposition from Senators from both political parties.

Senator Dodd got to work right away on a new version of the bill, which could garner bipartisan support but abandoned these efforts in mid-March when it became clear that bipartisan support would remain elusive. The largest point of contention has been President Obama’s proposed stand-alone consumer financial protection agency. The House included the President’s version of the agency in its HR 4173 bill. Senator Dodd has decided to place the agency within the Federal Reserve, but maintains that it will remain independent, regardless of its location.

Once Health Care Reform has made its way through the Senate, it is likely that more attention will be paid to rewriting financial regulatory rules. Since the House has passed its version, lawmakers are waiting for the Senate banking committee to markup its version of the bill. Once the Senate passes its bill, it will have to be combined with the House version, and differences will have to be ironed out (in Committee), to send one final bill to the President for his signature. It has been almost a year and a half since the financial crisis was at its most acute, with negative impacts on lending and economic activity. Congress will likely act soon to address the gaps that brought the country to this point.