by Xinhua Writer Liu Lina

    WASHINGTON, Dec. 8 (Xinhua) -- As the world closely watching, the U.S. financial regulatory overhaul is in the process of legislation. Important and complicated, the reform derived from the still unfolding impact of crisis tests the future of the financial structure not only domestically, but also globally.

    Since the U.S. Treasury Department proposed its financial regulatory plan to the Congress this summer, when the U.S. economy was still in deep recession, key players of the reform, including Treasury Secretary Tim Geithner, the Federal Reserve (Fed) Chairman Ben Bernanke, and Federal Deposit Insurance Corporation (FDIC) Chairwoman Sheila Bair, have frequently made remarks on the issue.

    Two powerful lawmakers - Chairman of the Financial Service Committee of the House Barney Frank, and Senator Christopher Dodd, who chairs the Senate Banking Committee, are the leading roles of the legislative process.

    The House's bill is scheduled for a floor vote this week. However, the Senate's version proposed by Dodd differentiates the House's plan.     

    FIVE KEY TOPICS

    The financial crisis was deeply rooted in systemic risks, upon which the financial reform is a systemic project with numbers of topics.

    Yet, there are five key issues, where the conflicts of interest embedded, that draw most of the reformers' attention.

    "Too big to fail" tops the list. This phrase came from last autumn when the government realized after the collapse of Wall Street investment giant Lehman Brothers that some big financial institutions could not fail otherwise they will drag the whole system down. But the bail out effort taken by the government for the big financial firms caused controversial "moral hazard" debate. The critics say that it is not fair to use taxpayers' money to save big banks.

    Some economists, like Paul Volker, the former U.S. Federal Reserve Board chairman who is now a member of President Barack Obama's advisory team on the economy, believes that the best way to solve the "too big to fail" problem is to split and downsize the big financial firms. While the mainstream economists and policy makers do not agree with that.

    "Given the global competition, it is not practical to split the big financial institutions," Sun Tao, economist of the International Monetary Fund (IMF) told Xinhua in a recent interview. "What can be used includes increasing capital ratio, tightening regulatory standards and so on."

    "When you have the complexity in the system and you have a high degree of leverage, you are probably going to create an accident down the road. However, I don't think the government should simply break these big banks up," said Robert Kaplan, one of the top 25 business thinkers named by the Financial Times in 2005.

    Like other reform proposals in Congress, the Dodd plan imposes costs -- like higher capital requirements - on large and interconnected firms. The aim is to make size and complexity so costly that firms opt to be smaller. The plan stops short, however, of creating a fail-safe mechanism to break up "too big to fail" firms - before they fail - if incentives to downsize don't work.

    The No. 2 is consumer protection. The lawmakers and the administration all call for a Consumer Financial Protection Agency to ensure that financial products sold to the public are in consumer's best interest. But the Federal Reserve Chairman Ben Bernanke opposed it and said that protecting consumers is in line with the central bank's responsibility.

    The No. 3 is the derivatives regulation. An overarching goal of reform is to ensure that derivatives are traded on public exchanges rather than as opaque and risky private bilateral contracts.

    Proposals in the House and by the Obama administration undercut that goal by exempting derivatives from exchange trading for corporations that use them to hedge risks, like a utility that wants to hedge against swings in energy prices. The Senate's plan would correctly leave it up to the regulator to rule on any such exemptions.

    The No. 4 is bank regulation. The House and administration would distribute supervisory powers among the Federal Reserve, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency. The Senate calls for the creation of one main federal regulator, reasoning that a single regulator would end "regulator shopping" -- whereby banks choose their own overseer, invariably opting for the weakest one.

    The role of the Federal Reserve is the fifth big concern of the financial overhaul. The House and the administration propose new bank regulatory powers for the central bank. But they have not called for the changes needed in the clubby and secretive Fed system to exercise its new powers in an unbiased and transparent way. Senator Dodd's plan pulls in the opposite direction. It would strip the Fed of regulatory powers.

    "The Federal Reserve should be more focused on currency policy," said Dodd on Dec. 3 at the Senate Banking Committee's hearing of confirmation vote of Fed Chairman Ben Bernanke's second term. But Mr. Bernanke emphasized that the expertise was essential to financial regulation. He also argued that the central bank was already transparent enough.

    Besides the topics above, issues like limiting financial executives' compensation, tightening standard of rating agencies and trans-territory regulation coordination are also among the hot debate.     

    THREE UNCHANGES

    Reform aims at change. However, there are major factors, which affect the fundamental of the U.S. financial system, remain unchanged.

    First, the key principle and top priority is unchanged. Financial industry is one of the pillar industries of the U.S. economy. To keep this sector relatively competitive around the world relates to the core national interests. The Obama administration will not reform the financial system at the price of its global competitive advantage. That is the reason why the "too big to fail" issue has been dominating headlines of media for such a long time.

    Second, the relationship between the Wall Street and the government is unchanged. Definitely, the financial reform has trimmed some power of the invested interest, yet the basic relationship between the Wall Street and Washington is relatively as same as what it was before the crisis. Some critics said that the government has been kidnapped by the big banks. As one of the editorial on New York Times said recently, after two years of financial crisis, Wall Street still dominates Washington.

    Third, to keep the innovating spirit of American financial sector remains unchanged. As President Obama said repeatedly, one of the fundamental engines that made the America great is the spirit of innovation. Although innovation in the financial sector has been widely criticized due to the ongoing crisis, the financial innovation will not die in the future.

    On the contrary, as Leo Melamed, one of the pioneers of the financial futures put it, financial innovation, such as derivatives will self improve. The IMF also said in a recent report that called to reset asset securitization -- the most criticized financial products during this crisis -- in a proper timing.     

    UNCERTAINTY REMAINS

    With most advanced financial system, the U.S. still dominates the world financial standard setting process. No wonder many experts say that when the U.S. reforms, the world watches.

    Despite the financial crisis burst, "the U.S. remains the world major rule maker." Professor David Lampton, Dean of Faculty of Johns Hopkins University, told Xinhua.

    Most large and interconnected firms are global, and thus would require an international resolution system to dismantle them in a crisis. Resolution authority for American regulators is a necessary step to confront the nation's outsize financial sector, but it is not a sufficient fix for the "too big to fail" problem.

    With the House moving forward and a Senate plan on the table, opportunities exist for strong reform. The other option, which also exists, is that lawmakers will entrench the status quo under the guise of reform.

    So far, the blueprint of the U.S. new financial structure is still under the water.

    "We all agree that there are fundamental flaws in the American financial institutions." Harry Harding, public policy professor of Virginia University, told Xinhua, "Until now, we still don't quite know how to deal with that. How it should be regulated. This is going to be a very significant debate."

    President Obama pledged to lay a new foundation for the next generation through change and reform. Yet, as the year 2009 coming to an end, what will the U.S. financial sector look like in the "new responsible era" as Obama vowed in his inauguration address, remains uncertain.

Special Report:  Global Financial Crisis