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Published on April 2, 2008

US Treasury Secretary Henry Paulson has unveiled a blueprint to reform the financial system in the most drastic fashion since the Depression. Essentially, the plan will add more teeth for the Federal Reserve to regulate and supervise the different types of financial institutions and the financial markets. Other regulatory agencies will see their power merged or taken away. Some have already dubbed the new expanded role of the Fed as a "supercop". Are the US authorities addressing a severe mortgage and credit crisis that is now engulfing the financial system as a whole? Unfortunately, the answer is a big no. Senate Banking Committee chairman Chris Dodd, a Democrat, is correct to have called the Bush administration's proposal a "wild pitch".

"It's not even close to the strike zone," Dodd said. "This is a very legitimate issue, but why bring this up when this had nothing to do with the current problems we're facing?"

Yes, why is Paulson bringing up financial sector reform when the US is facing the deepest financial crisis since the Depression? Actually, the financial blueprint is an ongoing process that was initiated more than a year ago. It will only come into effect with legislative support from Congress. President Bush has brought Paulson, the former head of Goldman Sachs, in to undertake this task. But what the US economy needs urgently is a comprehensive plan to fix the mortgage and credit crisis as well as a medium-term prospect of how to deal with ailing US financial institutions, which are about to see their capital wiped out.

This is a bad time for financial institutions worldwide, which are getting US flu. Already UBS Group, the European financial services group, has reported losses of a staggering US$12 billion (Bt378 billion) in the first quarter of 2008. It will be in need of fresh capital to make up the losses. It seems that the US administration is trying to push out the financial blueprint to downplay the crisis. Most Americans have elected to deny there is a big problem. The problem has gone beyond the mortgage and credit crisis but is spreading out to threaten the capital of the financial institutions. Repairing the damage will take years. 

The Fed has already done the unthinkable by bailing out Bear Stearns and providing liquidity to non-banks in order to prevent the crisis from bringing down the whole US system. The Fed has made the right decision to do so, otherwise the crisis will reach a point of no return. Now the Fed is pumping in unlimited liquidity to make sure the system survives. The US financial system is afflicted by sub-prime debt amounting to $1 trillion. So far $200 billion has been written off. Lowering interest rates won't cure the bad debts.

What the Americans need next is a federal bailout of the bad debts. There will be a big battle on this front and finger pointing. Then they might also want to rewrite accounting rules to allow financial institutions to take losses over a period of several years. This will also require a big change in the accounting rules.

Once the Americans get these two tasks completed, they can move ahead to ponder how to fix the financial system or regulate financial products. Should they regulate the hedge funds with tighter rules? How can they restore the financial intermediary role of the financial institutions and restore their balance sheets? The Americans will have a big mess to clean up several years down the road.  

The Nation