The Obama administration on Wednesday will unveil its long-awaited plan to tighten U.S. financial regulation, marking a test of its resolve to seize political opportunity and face down powerful interests.
Banks and financial firms are pushing hard in Washington to soften the plan, which has been under debate for six months in response to a severe credit crisis and a deep recession that is already going a long way toward reshaping capital markets.
Political realities on Capitol Hill, where the industry is deeply entrenched and lawmakers protect their turf, have already tempered some approaches for bringing the antiquated U.S. regulatory system into the 21st century.
Treasury Secretary Timothy Geithner is scheduled to testify in congressional hearings about the plan on Thursday.
In the short-run, the plan's substance will be less important than the appearance it creates, analysts said.
In this environment ... regulation is not an industry issue. It's a political issue. The government needs to be seen as responsive and doing something, said Dushyant Shahrawat, senior research director at research firm TowerGroup.
Months of debate on the details lie ahead, with time on the side of the status quo, especially if the economy continues to improve and public outrage begins to fade. Republicans last week proposed more modest reform proposals.
In the long run, whatever changes get made, investors shouldn't expect the bulls and bears of the market to be tamed, although the financial system will likely be warier of risk, more transparent and more stable for a time, analysts said.
Financial leverage is already down sharply, while a massive dose of skepticism about asset values has been injected into banking, and financial executives are likely keen, for now, to avoid more embarrassing testimony before Congress.
I'm not willing to say that that will continue on endlessly, Shahrawat said. Firms have a bad habit of going back to old habits. But at least for the next three to five years, I don't think risk will be as big an issue.
One example of the administration's partial retreat from earlier reform intentions has to do with existing regulatory agencies -- such as the Securities and Exchange Commission and the Commodity Futures Trading Commission.
Reorganizing these bureaucracies was once seen as vital to closing gaps in oversight and blocking financial firms from shopping around for the least strict regulator. For instance, American International Group was under the jurisdiction of the Office of Thrift Supervision, a savings-and-loans overseer, when the giant insurer was bailed out by taxpayers.
But no top-to-bottom agency overhaul will be proposed, said sources familiar with administration discussions.
The White House and congressional leaders have decided that such a move is not politically feasible, given opposition in the industry and division among committees of Congress that don't want to lose their oversight of the SEC and CFTC.
Some streamlining of bank supervisors will be urged, although formation of a single regulator for all banks -- also politically difficult -- is not expected.
Formation of new entities will be called for, including an inter-agency council to oversee systemic risk in the economy and new duties in that area for the Federal Reserve.
While these and other initiatives represent substantive reforms, the risk of putting off politically difficult changes now is that they will never be revisited, leaving the economy vulnerable to another crisis later, said analysts.
We had a unique period where the development of financial markets just outpaced the ability of the regulators to keep up in the past 20 years or so, said Joe Engelhard, senior vice president at research firm Capital Alpha Partners.
There's no question that at the end of this process, the financial regulatory structure will have caught up a little bit to the markets ... The danger would be without rationalizing the agencies, the markets will outrun the regulators again.
Among proposals expected to be in the plan is one that would empower the government to take over and unwind troubled firms which are not banks, but which pose risk to the economy. The Federal Deposit Insurance Corp, which already has such resolution authority for banks, may be tapped for this job.
On restraining sky-high executive pay, the Obama administration's package is expected to endorse long-debated changes in U.S. corporate governance that could exert pressure for moderating managers' compensation.
Chief White House economic adviser Lawrence Summers said on Friday that a central reform element must be ensuring that financial firms have adequate capital, an area with broad international implications.
Finance ministers for the Group of Eight rich nations at a meeting in Lecce, Italy on Saturday called for strengthening our commitment to standards of propriety, integrity and transparency in world finance. The G8 ministers issued a set of principles called the Lecce Framework.
The European Union has moved out briskly on reform, already announcing plans for a systemic risk council and a crackdown on hedge funds, but tensions must be resolved over the regulatory roles of the EU and its 27 member nations.
New rules for hedge funds and over-the-counter derivatives markets are expected in the Obama plan, as well as a proposal for creating an agency to oversee the safety for consumers of financial products ranging from credit cards to mortgages.
Such an agency would be a big help for protecting bank customers, who have had no consumer protection whatsoever, said Mercer Bullard, a law professor at the University of Mississippi and leading advocate for mutual fund investors.