Treasury to Unveil Regulatory Overhaul

The Treasury Department Monday plans to propose a sweeping plan to revise the nation's financial regulatory system, including giving the Federal Reserve broad authority to ensure the stability of financial markets, according to published media reports.

The plan comes as the financial system is enmeshed in a massive credit crisis triggered by Wall Street's love affair with debt linked to risky subprime mortgages and exacerbated by the explosive growth of largely unregulated financial derivatives.

The Treasury's proposal is likely to come under fire from Democrats and other proponents of even stronger regulation of investment banks and markets for newer financial products. Notably, the Treasury's plan does not propose tighter regulation of markets for hedging risk, like the market for credit default swaps, according to The New York Times, which reported Saturday on the proposal after obtaining a summary of it from the Bush Administration.

The proposal would need to be passed by Congress, and thus is likely to trigger a contentious debate among lawmakers, financial industry representives and regulatory agencies, The New York Times report noted. Democratic lawmakers, led by Sen. Barney Frank (D., Mass.), have already been calling for even greater regulation of investment banks.

The Treasury proposal would give the central bank the authority to scrutinize any financial player that poses a risk to the overall financial system, the Times' report said. But it would not apply the same kind of everyday regulations already governing commercial banks to investment banks, the report added.

This is likely to be a source of controversy, as Frank and others have argued that investment banks need to be regulated like depository institutions. Their calls have come after the Fed was forced to help engineer the rescue of investment bank Bear Stearns(BSC Quote - Cramer on BSC - Stock Picks) earlier this month in order to head off a broad financial meltdown. At the same time, the Fed opened its discount lending window, which since the Depression has been reserved for commercial banks, to investment banks. The argument from proponents of stronger regulation over investment banks is that if they are big enough to require rescue from the nation's central bank, then they need to be subject to the same rules as their commercial brethren.

The Treasury proposal would revamp the nation's plethora of financial regulators, merging some agencies into others, the report said. For example, a "Prudential Financial Regulator," would oversee banks, which are currently regulated by five federal agencies. This new office would be allowed to send officials into any depository institution that is protected by federal guarantees such as deposit insurance, the report said, adding that this office would eliminate the distinction between banks and thrift institutions.

Another overseer would merge the responsibilities of the Securities and Exchange, which oversees the stock and bond markets, and the Commodity Futures Trading Commision, which regulates trading in futures contracts for commodities and currencies, the report said.

However, the plan would actually further limit the SEC's existing powers, by allowing stock exchanges to regulate themselves more and by making it easier for them to approve new products, the report said. Such goals are part of Treasury Secretary Henry Paulson's past efforts to reduce regulation on U.S. markets that he contends make them less competitive with overseas bourses, the report added.

Treasury is also proposing to create for the first time a national insurance regulator, which would take over the duties currently performed individually by the states, the report said. This would eliminate the patchwork of regulations by 50 different authorities, but it is likely to be met with a backlash from the states' insurance regulators.