Three cheers for Paulson's plan

The Treasury Secretary's proposal to give the Federal Reserve more power to regulate Wall Street isn't perfect. But it's a step in the right direction.

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By Paul R. La Monica, editor at large

Should the Federal Reserve be given more power to regulate mortgages and the stock market?
  • Yes
  • No

NEW YORK ( -- Is Treasury Secretary Henry Paulson's plan to overhaul the financial services industry going too far? Not far enough? Does the plan put too much power in the hands of the Federal Reserve?

Let the debate begin.

But one thing is certain - Paulson's proposal is a step in the right direction, making the Fed a "market stability regulator" with broad powers to supervise investment and commercial banks.

As I wrote last week, it's clear that the entire financial-services industry needs to be policed more ruthlessly.

The mistakes made in the past few years by mortgage lenders, banks, brokers and hedge funds have caused the current subprime mess.

And as much as the free market champion in me thinks that the painful memories of this credit crunch should be enough motivation for Wall Street to police itself, financial institutions no longer deserve the benefit of the doubt.

Some critics of Paulson's plan may argue that the overhaul does not do enough to address current problems.

But Bear Stearns (BSC, Fortune 500), Countrywide (CFC, Fortune 500), Citigroup (C, Fortune 500) and other big financial firms have already had their meltdowns. And Paulson can't get into Mister Peabody's Wayback Machine to stop them from engaging in risky practices.

The point of any regulatory change should be to come up with solutions to prevent future crises and not waste time pointing fingers about who deserves the most blame for this one.

With that in mind, my biggest concern is that Paulson's proposal may be too complicated. Eliminating several current agencies and merging numerous others into new ones may seem a smart move.

But Paulson may be simply creating new levels of bureaucracy. There is also the risk that too much power and responsibility may be placed into too few agencies. If regulators become stretched too thin and can't legitimately watch over Wall Street closely enough to prevent future crises from occurring, then this proposal is all for naught.

What's more, the Federal Reserve itself also has to act more responsibly. After all, the Fed, in response to the last recession in 2001, lowered interest rates to 1% and kept them at that level for a long stretch of time. So it too deserves some blame for the current credit crunch.

And if the Fed hopes to avoid the mistakes made earlier this decade, the Fed needs to realize that it may soon be reaching a point - with the federal funds rate now at 2.25% - where it may have to start raising interest rates so that banks and borrowers don't lapse into bad habits again.

"If you really look at what happened to create the housing bubble, it's because the Fed held rates artificially low for a long time. The abuses came on the heels of easy money creating opportunity," said Haag Sherman, managing director with Salient Partners, an investment firm in Houston.

Finally, there is the issue of consumers. It's true that the Paulson plan does not offer much in the way of help for subprime mortgage borrowers that are struggling to hold on to their homes. And this needs to be addressed as well. But it is being addressed, most notably by mortgage reform bills proposed by Rep. Barney Frank and Sen. Chris Dodd.

The key now is for Congress and the administration to work together and find some common ground and enact changes to Wall Street and the mortgage lending industry that will benefit consumers and investors. Paulson, Frank and Dodd are all on the right path. It's a welcome start.

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