Tuesday, April 1, 2008

No Surprise in This Surprise

Yesterday, U.S. Secretary of the Treasury, Henry M. Paulson, Jr., announced a proposal that hailed as a sweeping reform of the U.S. financial system. In an effort to restore strength in the nation's financial system, the secretary set forth a list of proposed changes. Some of them would create new Federal entities. Others would subordinate existing agencies to other Federal agencies, changing their mission in some respect. Still others would move activities previously in the hands of the states under the supervision of Federal oversight. Many of these aforementioned proposals seek to give more responsibility to the Federal Reserve System

I am not in a position to, nor am I going to comment on whether this organizational structure is a good one or not. However, I do think that the proposed structure should not be a surprise to anyone with a memory that goes back to the previous administration. In 1999, the Congress passed and then President Clinton signed the Gramm-Leach-Bliley bill, also known as the Financial Services Modernization Act of 1999. This Act revoked the Glass-Steagall Act, passed in the 1930s. Glass-Steagall had, among other things, separated commercial and investment banking in the wake of the 1929 Stock Market Crash and the onset of the Great Depression. But Gramm-Leach-Bliley removed that separation. Indeed, it opened the financial markets up to new combinations - allowing banks to buy stock brokerages and insurance companies; brokerages to purchase banks and insurance companies; and insurance companies to set up or purchase brokerages and banks. At the time, many people feared a wide-scale rush to conglomerate that never happened. But the important part of the legislation, at least for purposes of this post, was to allow the existing regulatory structure to stay in place, but to name an "umbrella regulator" for some of the ensuing combinations. The "umbrella regulator" was given responsibility for overseeing and/or coordinating the activity of other regulators when it came to banks and bank holding companies that combined the firms.

And here's the relevance to this post. That "umbrella regulator" was the Federal Reserve. Part of the reasoning, as I understood it back then, was the potential for combined firms to present a problem for banks, and ultimately for that to manifest itself at the Fed's Discount Window. Now, to my knowledge, the increased responsibility did not result in a huge expansion of the Fed's staff or powers. This may be because the anticipated amalgamation of financial firms never came to fruition. But the framework, at least in theory, was put in place. In my opinion and given the situation, the resulting restructuring that we now are hearing about is the logical next step from Gramm-Leach-Bliley.

This is a significant restructuring, to be sure. But it should not be labeled as a "surprise," at least not in my opinion. But, as always, your opinions and comments are welcome. Do you think this is a "historic" moment in U.S. financial history? Or is it another step in the evolution of the nation's central bank?

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