It Won't Be Easy to Fix Wall Street

11/11/2009 11:36 am EST

Focus: MARKETS

Knight Kiplinger

Editor-in-Chief, The Kiplinger Letter, Kiplinger's Personal Finance, and Kiplinger.com

Knight Kiplinger, editor-in-chief of The Kiplinger Letter, says Congress and the president face an uphill battle in trying to regulate the financial system.

Over a year after Wall Street started to reel from a series of high-stakes bets that went from bad to worse, ultimately deepening the US recession, the prescription for an effective fix is elusive.

A regulatory overhaul is in the works, but anticipating and preventing a similar quake is a Herculean task that simply may not be possible.

A consensus that the absence of smart regulation over Wall Street’s risk taking contributed to the crisis isn’t translating into agreement on a better way. Congress will OK more consumer protections, including a watchdog agency to oversee credit cards, mortgages, [and] auto and other direct consumer loans.

More oversight of Wall Street firms is a given: Large hedge funds and big private pools of capital will be forced to register with the Securities and Exchange Commission, for example. And [there will be] closer scrutiny of more kinds of derivatives, perhaps through a clearing house to ensure standardized contracts and open trading.

Though it will slow financing deals, Congress won’t let these shadow banking firms continue to conduct their business out of sight of federal and state regulators. Effectively guarding against system risk involves being something of a seer, not reacting to yesterday’s crisis, but sussing out where tomorrow’s threat lurks. Plus, it means keeping tabs on a huge amount of territory—not just big banks, but hedge funds, private equity groups, insurers, [or] any firm with a big financial role.

No candidate for the job has everyone’s confidence. Sen. Chris Dodd (D-CT), chairman of the Banking Committee, says the Federal Reserve isn’t up to the task, having failed to spot, much less ward off, the danger Wall Street courted in recent years. Others fret that Dodd’s idea of a council of regulators would get snarled in turf wars, ending up in gridlock.

A leading alternative: a tag team consisting of the Treasury, which would finger troubled firms, and the Federal Deposit Insurance Corp., to usher them through restructuring.

One factor working against a solution: There’s not much political payoff. Most voters are baffled by the arcane workings of hedge funds, investment banks, and exotic financial vehicles and don’t know how important they are to the economy. Plus, the legislative timetable is short and the calendar more than full.

But voters do want to see Wall Street pay for the misery everyone is feeling, and lawmakers know they’ll take the rap if there’s another crisis like the last one. And they’ll get kudos from voters if the package includes limits on executive pay and stiffer rules on credit cards. So, look for a big push for a deal early in 2010.

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