The Treasury blueprint; Treasury Secretary Henry Paulson started a conversation in Washington when he proposed a sweeping blueprint for revamping regulation of U.S. financial services providers. Winners and losers are lining up on both sides of the proposal

Mortgage Banking, Sept, 2008 by Jack Milligan

John D. "Jerry" Hawke Jr. is an old Washington hand who understands how the country's financial services industry is regulated as well as anyone. Now a partner at the Washington, D.C.-based law firm of Arnold & Porter LLP, Hawke previously was comptroller of the currency--the agency that supervises nationally chartered commercial banks--from 1998 to 2004. Asked what he thinks of a recent proposal by U.S. Treasury Secretary Henry M. Paulson Jr. to drastically restructure how financial companies are regulated, Hawke doesn't pull any punches.

* "I don't like much of it," Hawke says bluntly. "Every 10 to 12 years, new people come to town and they look at the structure of the financial services regulation and say, 'Oh my God, we've got to straighten this thing out!"

* Another person with a full understanding of the financial regulatory system is Steve Bartlett, president and chief executive officer of the Washington, D.C.-based Financial Services Roundtable since 1999, and for several years before that a Republican congressman from Texas. Bartlett sees the Paulson plan--officially known as "The Department of the Treasury Blueprint for a Modernized Financial Regulatory Structure"--quite differently.

"I think the blueprint is the direction of the future," says Bartlett. "It's the direction the country has to go to stay competitive [with other countries] and [preserve] the safety and soundness of its financial institutions."

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There's no question that the Treasury blueprint has had a polarizing effect on the financial services industry, evidenced by the sharply divergent assessments from Hawke and Bartlett. Proponents of the Treasury blueprint are quick to point to the subprime mortgage crisis as justification for the most drastic and far-reaching change in the nation's financial regulatory architecture since the Great Depression.

The subprime mortgage market's steep downturn and lingering credit market turmoil have already led to the demise of the New York-based investment bank Bear, Stearns & Co. and Pasadena, California-based Indymac FSB, a federal savings bank. The crisis has also cost other large financial companies hundreds of billions of dollars in losses and helped tip the U.S. economy into a pronounced economic downturn.

Clearly, there is a growing sense in the financial services industry that the U.S. regulatory system has struggled to keep pace with developments in the marketplace.

Steve O'Connor, senior vice president of government affairs at the Mortgage Bankers Association (MBA), points to the case of Bear Stearns, which barely escaped bankruptcy when it was acquired in March of this year by New York-based JPMorgan Chase & Co. in a deal that was midwived by Federal Reserve Chairman Ben Bernanke. Bear Stearns' investment portfolio was filled with complex mortgage securities, including highly volatile collateralized debt obligations (CDOs), which could have driven the mortgage market even lower had it been liquidated en masse. Ultimately, the Fed stepped in because it feared that Bear Stearns failure posed a systemic risk to the U.S. economy.

"There is a growing consensus that [advancements] in financial services have outpaced the ability [of] the regulatory system to keep up," says O'Connor. "There are lots of highly leveraged players in the marketplace, and people don't know what [securities] they have on their books."

Supporters of the Treasury blueprint also believe that had some of its recommendations been in force just a few years ago, they might have lessened the severity of the subprime crisis--and perhaps even prevented it altogether. The banking and financial services industry remains under considerable pressure from a slumping U.S. economy, and the plan's boosters also wonder if the current regulatory system is capable of handling the slew of commercial and investment banking failures that could lie ahead.

"Not only are the blueprint's recommended changes warranted, I think the policy-makers at the Treasury Department understand the problem," argues Bartlett.

But whether some or all of Paulson's plan ever makes it into law is impossible to predict at this point. For starters, it is the brainchild of a lame-duck Treasury secretary during an election year when official Washington is preoccupied with a possible change in the political power structure. The plan also poses a threat to the entrenched interests of both the regulators and the regulated, and has the potential to set off the mother of all Washington turf wars. In a city that compulsively keeps score of such things, it would create a whole new list of winners and losers.

Released by the Treasury Department in March of this year, the blueprint represents Paulson's vision of what the country's financial regulatory architecture would look like if he were to start with a clean piece of paper and completely redesign it. And in the opinion of one financial trade association official, it betrays Paulson's professional background as a former chief executive officer at the New York-based investment bank Goldman Sachs & Co.