Even with the U.S. Treasury making an aggressive attempt to revamp the country's financial system, market experts believe that there is not much chance of this happening in 2008.
Secretary of the Treasury Henry Paulson has laid out a three-stage plan to restructure the U.S. regulatory system, including increasing the supervision and regulatory reach of the Federal Reserve so that investment banks, mortgage lenders, insurance firms, etc. will be falling under the Fed's purview.
"Coming out with something now is necessary from a public relations perspective," said Haag Sherman, chief investment officer at Salient Partners, a division of Sanders Morris Harris Group. However, Sherman said that there is little hope that the plan will be implemented this year. Further, with the possibility of a Democratic President winning in November, no one really knows what this proposal will look like in its final form.
Furthermore, Sherman said that although it is a sensible plan to consolidate the current regulatory framework, Paulson's proposal addresses the symptoms and not the cause of the dilemma that the U.S. is now facing. The root of the problem, Sherman said, is bad monetary policy, with the Fed having kept short-term rates far too low for a prolonged period of time.
"By keeping rates low, the Fed was practically giving the public free money, which they used to speculate in housing and other assets," Sherman said. As a result, this provided the perfect opportunity for unscrupulous lenders and other aggressive lending practices. "Until the root cause of the problem is addressed, new bubbles or problems are likely in the future."
Despite the intrinsic benefits that the Paulson plan can offer, increased regulation could potentially be detrimental to the businesses of the brokerage firms, and in turn, the market as a whole, experts said.
"If these brokerage firms are going to be regulated by the Feds the way banks are being governed, these companies are not going to be able to use much leverage," said a senior mortgage market observer. He added that with the increased scrutiny by regulators, these types of businesses would either have to reduce leverage by owning fewer securities or raise more capital. "That wouldn't be good for the market because that would reduce the level of liquidity."
Like Salient Partners' Sherman, the source said that it is unlikely that Paulson's proposed plan will be passed this year. "There's so much political posturing, but I don't think it will be a year of changes." He noted that with Democrats believing they have a 50% chance of winning the presidential election in November, there is very little possibility that a Republican-endorsed proposal would become law. Even if John McCain becomes president, the final version of the proposal might still account for differences between the presidential hopeful and President George W. Bush.
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