Wall Street vs. Main Street: The Regulatory Battle Begins Tomorrow

Shah Gilani

U.S. Treasury Secretary Timothy F. Geithner says the Obama administration's overhaul of U.S. financial regulations is aimed at creating a "boring" financial system.

But after President Barack Obama unveils this boring – and not-so-new – regulatory structure tomorrow (Wednesday), expect a pitched battle that will pit the interests of Wall Street players against those of everyday Main Street investors.

The outcome could well determine how quickly and completely this country's financial system rebounds from the ongoing crisis. And that outcome will also likely determine whether or not we'll ever have to face something as dangerous and damaging as this again.

By unveiling its proposals for revamping the U.S. regulatory architecture that houses the agencies and watchdogs responsible for safeguarding the financial system that supports our way of life, President Obama is touching off a bruising battle – but one that probably has an unfortunate, and predictable, outcome. Unlike the more-aggressive overhaul proposals Money Morning previously outlined for both the regulatory system and the U.S. banking system, the reality here is that the current set of regulators will survive.

The $64 trillion dollar question was whether or not the existing limp and dysfunctional alphabet soup of regulators that were supposed to be the watchdogs of our way of life will actually be reconstituted into a new stew with the same ingredients – or whether a new kitchen crew would be empowered to stop Wall Street from force-feeding the public its same old toxic menu.

Thanks to details that have already been leaked to the public, the answer is already clear.

Front running its own public offering of a regulatory makeover, the Obama administration has been systematically leaking the guts of the "white paper" it plans to deliver tomorrow. The reason for the soft opening is that President Obama wanted to avoid a knee-jerk reaction in the financial markets. Plus, there's a history of political backlash and negative public opinion when it comes to any balancing act regulating the powerful cabal of bankers and brokers.

The crazy patchwork quilt of regulators overseeing our banks, bankers, brokers, investment products and markets is an inventory of acronyms that includes:

• The Federal Reserve Board (FRB).
• The Office of the Comptroller of the Currency (OCC).
• The Office of Thrift Supervision (OTS).
• The Federal Deposit Insurance Corporation (FDIC).
• The National Credit Union Administration (NCUA).
• And the U.S. Securities and Exchange Commission (SEC).

But that's not the end of it. Operating under the SEC are certain "self regulatory organizations" (SROs), including the Financial Industry Regulatory Authority (FINRA) and the Municipal Securities Rulemaking Board (MSRB), which police their own registered and licensed persons, the products they sell and trade and the public who they deal with.

Then there's also the Commodity Futures Trading Commission (CFTC), and a slew of state regulators who also act to ensure the integrity of financial intermediaries, products, and markets.

The question on everyone's mind is this: "Where were any of these kitchen hands when all the burners on the financial stove were turned all the way up and every pot on the stove was boiling over?"

Citing the myriad signals and obvious cracks that regulators missed or egregiously overlooked would easily fill a few volumes. And while it is instructive and incumbent upon us to not forget our history – lest we repeat it – there is enough still fresh in our minds to avoid dwelling on the past in favor of taking steps to make sure something this potentially ruinous never happen again.

With such a mindset, it's natural to conclude that our failed regulatory architecture needs a serious overhaul.

In his inaugural speech, President Obama directly addressed the need for more effective and protective regulation of Wall Street. Echoing the president's public position, Treasury Secretary Geithner recently said to the Independent Community Bankers of America (ICBA) trade group, "I think the president believes we need to have a much more simplified, consolidated oversight structure."

But sadly, true to the inviolate nature of politics and the power of entrenched and vested money interests, this once-in-a-lifetime opportunity to actually tear down the failed structures that guarantee another economic collapse and to replace them once and for all with a substantive regulatory structure that can stave off future financial tsunamis isn't likely to happen.

It seems that the Obama administration's sensitivity to potentially jeopardizing what some are pointing to as signs of recovery by not calling for radical regulatory surgery has resulted in signals that the approach will instead be to empower existing regulators with more patches and some needles and thread. In a clear about-face, the administration is quietly soft-selling its upcoming agenda for regulatory reform by making the case that the overlap of multiple agencies actually prevents any one agency from being subjected to undue political or commercial interests or influence.

What the administration is billing as a "sweeping reorganization" of financial supervision actually results in few major changes – and does nothing to address the turf wars and political power of the congressional fiefdoms that serve the greater interests of their lobbying masters.

To say this is unfortunate is an understatement with no rivals.

There is nothing in the offering plate that addresses the failed doctrine of "Too Big to Fail." While there are proposals to rein in leverage and to toughen capital and liquidity standards there are no proposed limits on curbing the monster machines of finance that will only get larger and larger and will eventually figure out how to break out of any paper cage they're put in, meaning at some point they'll be at large and able to threaten the world again.

There is nothing that directly reins in over-the-counter derivative products, or the sales and trading of these highly speculative (make that "gambling") devices. Lately, we've been joined in our concerns by George Soros – king of speculators in his own right – calling for the complete abolishment of certain derivatives. But that's not going to happen, because too many banks make too much money off these "instruments" of economic destruction.

As we've noted previously, there is nothing to stop clever players from shopping the regulatory smorgasbord of supervision servicers to find a friendly hall monitor who will accept their made-up class cutting and test-avoidance excuses.

There is nothing to rein in the U.S. Federal Reserve's independent power as omnipotent God wagging the tail of the U.S. Treasury Department as it sees fit. In fact, the Fed will be offered more power and more control over the nation's largest financial institutions. That makes the too-big-to-be-controlled Fed a vested partner in the drive to make the system too big to do anything but fail.

There is nothing to address who really will have the newly proposed power to unwind institutions deemed to be a systemic threat. The idea is to empower a "council" to determine just who those systemic threats actually are. Will the council's power be absolute, or will that power go to the Fed, the Treasury, the FDIC, or all three to fight about? Although it's unlikely that special interests would ever try to lean on any of the competing supervisors charged with threatening the life of a major corporation making many insiders very rich, it conceivably could happen. Let's be honest – it already has.

What's supposedly new is the idea of a consumer-protection regulator. But here's the problem: Weren't all the regulators supposed to be consumer advocates all along?

The inclination to retain the failed patchwork of a regulatory-quilt-in-tatters would be a major victory for Wall Street. Unless the American public wants to subject itself to more and deeper financial catastrophes, it must weigh in on the battle against the Wall Street machine.

The opportunity to recreate the walls and bridges that once were in place and have been dismantled – and to build a new and better fortification to protect the country from the greed and avarice of a few too many – is right in front of us.

And we may not have this opportunity again.

To that end, we should not be lulled into a sense of false security by believing that the existing regulatory architecture can be fixed. What's being rolled out tomorrow is more about rolling over and pretending everything is now okay than it is about engineering real, substantive change.

It is now or never.

By electing President Obama, the majority of Americans voted for change. Whether or not we actually get that change is now largely up to each of us, and promises to be a function of whether or not we actually demand that change loudly enough.

[Editor's Note: Is it a new bull market, or just a bear-market rally that's going to separate investors from the last of their cash? For the shrewdest investors, it may not matter. A new offer from Money Morning is a two-way win for investors: Noted commentator Peter D. Schiff's new book – "The Little Book of Bull Moves in Bear Markets" – shows investors how to profit no matter which way the market moves, while our monthly newsletter, The Money Map Report, provides ongoing analysis of the global financial markets and some of the best profit plays you'll find anywhere – including such markets as Taiwan and China. To find out how to get both, check out our newest offer.

To read a related story on how the long-term dismantling of U.S. banking regulations set the stage for the U.S. financial crisis, please click here. That story, which appears elsewhere in today's issue of Money Morning, is available free of charge.]

News and Related Story Links:

• Reuters:
  U.S. financial regulation reforms outlined.
• Bloomberg News:
  Geithner Says U.S. Goal Will Be 'More Boring' Financial System.
• Yale Law School Avalon Project:
  Articles of Confederation.
• Wikipedia:
  "Too Big to Fail."
• Money Morning Market Commentary:
  An Open Letter to President-Elect Barack Obama: How a Regulatory Makeover Can Fix the Financial Crisis.
• Money Morning Market Commentary:
  Plan to Repair U.S. Banking System Unveiled by Former Hedge Fund Manager.
• Independent Community Bankers of America:
  Trade Group Web Site.
• Derivatives Dictionary:
  Directory.
• Money Morning Market Commentary:
  By "Shopping" for Regulators, Private Equity Firms Have Discovered How to Buy Banks – Leaving Taxpayers With All the Risk.

Shah Gilani

About the Author

Browse Shah's articles | View Shah's research services

Shah Gilani is Chief Financial Strategist for Money Map Press and boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker. He helped develop what has become known as the Volatility Index (VIX) - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk and established that company's "listed" and OTC trading desks. Shah founded a second hedge fund in 1999, which he ran until 2003. Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see. On top of the free newsletter, as editor of The 10X Trader, Money Map Report and Straight Line Profits, Shah presents his legion of subscribers with the chance to earn ten times their money on trade after trade using a little-known strategy. Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on FOX Business' "Varney & Co."

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