Don't be so sure Paulson's plan is a recipe for regulatory laxity

As I write this, Hank Paulson is finally giving his big speech on regulatory reform. But the great wave of reaction has been going on for a couple of days now. There are seven stories on the Paulson plan in today's WSJ alone.

My quick read of all the reactions is that Wall Street mostly likes the Paulson approach, while lots of Democrats and consumer-protection types are dubious. (So are the heads of regulatory agencies that Paulson wants to do away with, but that's to be expected.)

I guess, in the sense that the plan doesn't explicitly call for reining in hedge funds or new financial products, that split in reactions makes some sense. But not that much sense. As Paulson put it in the speech:

Those who want to quickly label the Blueprint as advocating "more" or "less" regulation are over-simplifying this critical and inevitable debate. The Blueprint is about structure and responsibilities – not the regulations each entity would write. The benefit of the structure we outline is the accountability that stems from having one agency responsible for each regulatory objective. Few, if any, will defend our current balkanized system as optimal.

The one truly new agency that would come out of Paulson blueprint would be what Treasury dubs the Conduct of Business Regulatory Agency. And my initial reading was that the CBRA could be--depending of course on how the law creating it was written and who happened to be running it--a far more aggressive regulator on matters of consumer protection than anything we've got now.

Law professor Larry Ribstein saw it the same way, although he's not thrilled at the prospect (via Dealbreaker):

[W]ith one regulatory agency we're likely to get fewer new financial products. Harvard's Hal Scott is quoted in the WSJ article as saying that we don't want a competition in laxity between agencies. But what is the optimal amount of laxity? Can we assume that government are acting appropriately when, for example, they squelch new products?

No, we can't assume government is acting appropriately when it squelches new products. But neither can we assume that it's acting appropriately when--thanks to big gaps in the regulatory structure--it allows for the sale of wildly dangerous new products to gullible/greedy consumers. Like, say, teaser-rate mortgages with no money down.

Either we're okay with a purely buyer-beware approach to financial products, or we're going to have to rely on a government agency to stand between the financial wizards and consumers and say no to some new ideas. Sort of like the FDA does with drugs. For good or ill, that's what the CBRA could be.