Financial Reform Watch

Toxic US Assets & Shuttle Diplomacy

The Obama Administration has stepped up its preparation for the G20 summit next week by moving on two fronts—a plan to purchase toxic assets from banks and a new regulatory regime for financial products and companies. Taken together, these emerging plans appear designed to allow President Obama to come to London saying the U.S. has addressed the three major pillars of a recovery program—stimulus, bank rescue and regulatory reform .

Today's announcement by Treasury Secretary Geithner of the plan for toxic assets follows the broad outline he announced to poor reviews last month. The stock market's swoon after the previous Geithner announcement was blamed on the lack of detail he offered. Today, Geithner described how a program of up to $1 trillion to relieve banks of bad assets will be managed. Based on a public/private partnership concept, the Geithner plan allows for the participation of hedge funds and private equity funds as managers of portfolios of assets. Those managers will have the opportunity to make significant profits if they are successful in selling those assets back into a healthier market in the future. The government will also share in those profits. The reaction of the media and Congress to this plan bears watching. They will focus immediately on the issue of executive compensation for managers participating in the program and on the issue of allowing the very kind of firms that helped create the mess to make a profit on cleaning it up. Careful selection of managers will be crucial.

On the regulatory front, the emerging Obama plan appears to be set to rely more on transparency than on aggressive enforcement. All financial products—even those previously unregulated—would be traded publicly on exchanges with strict rules on disclosure of risks. The Federal Reserve would be given the role of "systemic regulator" to oversee the entire system and have the power to reach into financial firms not otherwise regulated by the federal government to address structural problems. The Securities and Exchange Commission would continue to perform its present functions and may also be tasked with overseeing hedge funds. Executive pay oversight— and possibly limitation—will certainly be a part of the plan as well. More details may emerge as early as this week, but almost certainly before the G20 meeting.

The overarching question of both of these major initiatives is—"Do they do enough?" Does the public/private approach of the toxic asset plan ensure the taxpayers' interests are adequately protected or does it allow for mischief by the private managers? Will a regulatory regime that relies mostly on transparency in a regulated market prevent the development of new, more exotic financial products in the future that could introduce new risks into the system? The other G20 nations, the American media, Congress, and the public will be asking these questions and more between now and the beginning of the London meetings.

With two weeks to go before the G20 summit, it appears to be too early to discern the policy areas where countries are making progress. The objective of a grand bargain, as originally intended, that would include coordination of monetary and fiscal policies, modernized on financial regulation, advancement on trade liberalization and reassessment of international financial institutions, may still be achievable but is still not a done deal.

Government leaders are pursuing their tours of the globe to pave the way for an agreement. French Prime Minister François Fillon and the Minister of Economy and Finance Christine Lagarde are in Washington today for G20 discussions with Larry Summers, Economic Advisor to President Obama and with Vice President Joe Biden. Gordon Brown is leaving later this week for the U.S., Brazil, and Chile in an effort to build more international consensus for the G20.

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