Convictions: Slate's blog on legal issues

Remember SOX!

According to the New York Times, the Treasury Department is pushing a plan which broaden and deepen the reach of the federal government into America's financial markets:

According to a summary provided by the administration, the plan would consolidate an alphabet soup of banking and securities regulators into a powerful trio of overseers responsible for everything from banks and brokerage firms to hedge funds and private equity firms.

While the plan could expose Wall Street investment banks and hedge funds to greater scrutiny, it carefully avoids a call for tighter regulation.

The plan would not rein in practices that have been linked to the housing and mortgage crisis, like packaging risky subprime mortgages into securities carrying the highest ratings.

The plan would give the Fed some authority over Wall Street firms, but only when an investment bank’s practices threatened the entire financial system.

And the plan does not recommend tighter rules over the vast and largely unregulated markets for risk sharing and hedging, like credit default swaps, which are supposed to insure lenders against loss but became a speculative instrument themselves and gave many institutions a false sense of security.

Parts of the plan could reduce the power of the Securities and Exchange Commission, which is charged with maintaining orderly stock and bond markets and protecting investors. The plan would merge the S.E.C. with the Commodity Futures Trading Commission, which regulates exchange-traded futures for oil, grains, currencies and the like.

All of which may sound good now, in the heat of the moment.  But so did Sarbanes-Oxley ("SOX") when it was first proposed -- and according to UCLA law professor Stephen Bainbridge, the results haven't been great: "The lesson is that when something MUST be done, the best thing to do may be nothing. Not, to be sure, the politically wise thing, but the right thing. Unfortunately, we’re in the same sort of environment that led to SOX." 

A tectonic shift on Wall Street?

In an incredibly opaque speech to the U.S. Chamber of Commerce yesterday, Treasury Secretary Henry Paulson implied that he would seek "the same type of regulation and supervision" for investment banks as that which exists for commercial banks.  He made the comment while defending the Fed's moves to front $30 billion to support the rescue of the ailing Bear Stearns investment bank. But, Paulson stopped short of encouraging a massive regulatory push -- saying that "recent market conditions are an exception from the norm" and that "bank regulation . . . is fundamentally different from non-bank regulation." 

It's not clear yet how much legal or regulatory change is coming to emerge from the Bear Stearns crisis, or the sub-prime mortgage meltdown.  But a front-page article ($) in Monday's Wall Street Journal speculated these crises would bring a tectonic shift in the way American law treats business:

The idea that less regulation is better for the economy has held sway in Washington since the Reagan administration. Now that consensus is crumbling, posing a potentially costly challenge to business no matter who wins the White House in November.

The crisis in the nation's housing market, the recent turmoil on Wall Street and a series of safety scares involving food, drugs and toys are driving both political parties to reconsider how much companies and markets should be relied upon to police themselves.

Even under the pro-business Bush administration, it appears the question isn't whether the government will enact tougher rules for various parts of the economy, but just how much stricter those rules will be. The new climate has some business groups girding for battle against what they fear could be onerous new requirements.

"We're in for a potentially significant regulatory response," said Glenn Hubbard, dean of Columbia University's business school and a former chief economist for the Bush White House, referring to the credit crunch and its impact on financial markets. "The hope is we won't overreact."

Today's reactions ($) to Paulson's speech seem to confirm that such a tectonic shift is underway.  I think some regulatory improvements are in order, but like Prof. Hubbard, I think there's also a significant risk of overreaction here.  And more broadly, I worry that we might be looking to law as a false panacea for all that ails American capitalism today -- and specifically, what afflicts the mortgage market.  There are limits to what the law can accomplish, and I don't know that re-regulation or toughened financial laws will do what we want here.  What do you think -- is this tectonic shift away from deregulation a good idea?  What is the proper role for law in America's financial markets?