The Obama administration's regulatory reform plan is struggling due to its complexity and needs to be slimmed down. The plan would fare better and potentially achieve some good if it were concerned less with tangential issues of interest only to the Federal Reserve Board and focused instead on averting future economic disruptions.

The proximate cause of the current downturn was the meltdown of the securitization markets, and that is where a reform plan should be directed. Securitizations had become a major international economic engine, but there was no effective control. Instead there were a lot of incentives for brokers and investment banks to stomp on the accelerator and hold it down until the engine blew up. When the markets imploded, the repercussions affected everyone who relied on those markets for funding and to trade assets at full value.

The key question is why existing market regulation failed to stop that from happening. It is not hard to see that there are three main culprits — the Securities and Exchange Commission, the rating agencies and mark-to-market accounting.

The SEC had primary responsibility for the investment banks and the securities markets. What many people do not realize is that the SEC had developed a regulatory scheme for the companies operating internationally that was designed to qualify as consolidated regulation similar to the Fed's supervision of bank holding companies. The SEC program required minimum capital levels and robust risk-control programs to avoid the kind of meltdown that Bear Stearns and Lehman Brothers suffered. Five companies participated in that program, two of which were Bear Stearns and Lehman Brothers. The other three were Goldman Sachs, Morgan Stanley and Merrill Lynch, all of which now operate as or are owned by a bank holding company, mostly because of access to liquidity. Understanding why the SEC's oversight failed is the obvious place to start in developing ways to prevent similar problems in the future. Of particular interest is whether these companies could have remained with the SEC if it had provided a source of liquidity similar to the Fed's discount window.

The rating agencies are supposed to rate assets according to risk, and obviously failed to do so in a very fundamental way. Most investors look no further than the rating on a security, and confidence in the credibility of ratings is obviously critical to the successful functioning of the securities markets. Ensuring that future ratings are reliable is another key to averting future disruptions. That might also eliminate the need for a new consumer protection agency.

Rating agencies should have refused to give a safety rating to the poorly underwritten mortgages that ignited the current downturn. That would have cut off the financing for those toxic assets and enabled the market to police itself. Perhaps a government rating agency should be considered as part of this plan. That would protect consumers and investors.

Finally, mark-to-market accounting played a major role in sending countless balance sheets into a downward dive far more severe than actual economic losses justified. This is what propagated the damage from the securitization markets throughout the whole economy. It simply makes no sense to require mark-to-market writedowns of receivables and income securities in a depressed market if the owner can and will hold the asset and collect its income until it pays in full or can be sold for an acceptable price. Reform of that radical and impractical rule could go far to limit the damage from future market cycles.

A means to regulate systemic risk companies is also needed. That would have two basic parts — identifying and overseeing the companies that qualify and providing liquidity and receivership if needed to minimize damage to the broader economy. In that regard, providing liquidity was the most important thing the government did to contain the current downturn, and the Treasury Department, Congress and the Fed all deserve praise for the actions they took when the downturn began. The problem is that they were making up the solutions on the fly, and it would obviously be better to have a system and resources in place for the future.

A plan that focused on these matters might not be a slam dunk, but it would bring the debate around to the things that need to be addressed to avert future market disruptions. These issues are not overly complex and it should be possible to develop effective solutions.

The administration's current plan is a muddle because it has been designed more to promote the Fed's self-serving agenda than to identify and resolve the underlying causes of the economic downturn.

The Fed has disrupted a productive reform effort by interjecting a proposal to kill the strongest and safest banks in the nation solely because the Fed doesn't regulate the owners (but not to fear, the holding companies are regulated by the banks' regulators). It is now generally understood that industrial banks played no role in causing the downturn, yet a centerpiece of the plan is snuffing out every kind of bank exempt from the Bank Holding Company Act, something the Fed has been trying to do without success for 40 years. That serves no one's interests but the Fed's and has left most people confused about what the plan will do to stabilize the financial markets. The securities markets are broken and that is where we need to pay attention.

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