Giving the Fed more clout

WASHINGTON -- President Barack Obama is expected Wednesday to propose the most sweeping reorganization of financial-market supervision since the 1930s, a revamp that would touch almost every corner of banking from how mortgages are underwritten to the way exotic financial instruments are traded.

At the center of the plan, which administration officials are referring to as a "white paper," is a move to remake powers of the Federal Reserve to oversee the biggest financial players, give the government the power to unwind and break up systemically important companies -- much like the Federal Deposit Insurance Corp. does with failed banks -- and create a new regulator for consumer-oriented financial products, according to people involved in the process.

The plan stops short of the complete consolidation of power that some lawmakers have advocated. For example, it will allow several agencies to continue supervising banks. It also won't place specific limits on the size or scope of financial institutions, but it will make it much harder for large companies to be so overleveraged that they threaten the broader economy.

After Mr. Obama details his proposal, the process will quickly move to Capitol Hill, where Congress would have to pass legislation to enact the changes. Treasury Secretary Timothy Geithner is scheduled to appear before both Senate and House panels on Thursday, where he is likely to face questions and criticisms.

Lawmakers are expected to take issue with several of the plan's more thorny issues, including how to create a system that won't simply bail out large financial companies when they topple. Giving the Fed more clout -- in light of recent criticism from lawmakers, both Republican and Democratic, of its secrecy and accumulation of power -- will also be a controversial idea.

Democrats in Congress could push for more consumer-protection powers and stricter limits on executive compensation than administration officials want. And bureaucratic turf wars could emerge as some authorities are reapportioned.

Administration officials say their goal is to make it less likely the economy will ever again teeter on the brink of collapse by giving policy makers more tools to arrest a crisis the next time one occurs.

They envision a less volatile financial marketplace where banks are encouraged, through tougher capital, liquidity and leverage requirements, to take fewer risks that have the potential to destabilize the economy. Hedge funds would be forced to register with the government and may face federal supervision if they are large and complex enough. Mortgages and other consumer products would be monitored by a new watchdog, and there would be global transparency rules over exotic financial instruments.

"Considerations of stability, safety and systemic risk have to loom larger in the planning, thinking, and strategizing of every financial institution going forward than they have in the past," White House National Economic Council Director Lawrence Summers said in a speech on Friday.

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The proposal won't sweep away the confusing and sometimes overlapping patchwork of state and federal supervisors that often clash over jurisdiction. Critics say institutions have been shopping around for the regulator with the lightest touch and that systemwide problems fell through the cracks.

In fact, the proposal could lead to the abolishment of just one agency -- the Office of Thrift Supervision. With the proposed new consumer agency, the number of agencies overseeing finance would remain unchanged.

Officials say the goal is to distribute power in such a way that gaps in oversight are removed and the opportunities for regulator shopping reduced.

Policy makers have pushed sweeping changes over the regulation of financial markets before with mixed results. In March 2008, then Treasury Secretary Henry Paulson proposed an overhaul of supervision, but Congress didn't take up the ideas.

Other efforts have had unintended consequences. The Clinton administration won legislation that broke down Depression-era barriers between commercial banking, investment banking and insurance, among other things. Mr. Obama has criticized that law for helping create some of the financial behemoths that threatened the economy last year.

The current White House, which made the revamp a centerpiece of its early months in office, is keen to move fast. "Experience teaches that once the crisis has passed, the will to reform will pass as well," Mr. Summers said in his speech.

The plan calls on the Fed to oversee financial institutions, products, or practices that could pose a systemic risk to the economy. It will create a "council" of regulators to monitor this area as well. Government officials believe this arrangement will forestall companies from growing large and overleveraged without substantial federal supervision, as happened, for example, in the case of giant insurer American International Group Inc.

The Fed will likely have the power to set capital and liquidity requirements for the U.S.'s largest financial companies and scour the books of a wide range of firms. It is unclear what enforcement powers the central bank will have; that likely will be a point of contention as lawmakers debate the issue.

How the Fed interacts with this council also will be a subject of debate. Administration officials envision the council being able to recommend that a specific company, product or practice be subject to Fed supervision, with the central bank ultimately accountable for each area or company that poses the systemic risk. This could set up clashes between the Fed and the council, especially if one is more hawkish than the other.

The goal is to avoid repeating a situation akin to the collapse of Lehman Brothers Holdings Inc., where the government had no authority to smoothly unwind the failing institution. A step such as this is expected to be exercised only rarely, and it could first require approval by the Treasury Department, Federal Reserve, and FDIC, people familiar with the process said. Once a company is placed into receivership, the process will likely be run by the FDIC. It is unclear how such a program will be financed.

On some potentially divisive issues, the administration tried to find a delicate balance, people familiar with the process said. For example, it won't call for the Securities and Exchange Commission to merge with the Commodity Futures Trading Commission, being unwilling to expend political capital on the battles with congressional fiefdoms that this move would spark.

But the proposal will push for much more "harmonization" between these two agencies. There has long been tension between them because many of the companies overseen by the SEC trade derivatives and other products regulated by the CFTC.

The new regulator overseeing consumer protection is expected to take some areas that once belonged to the Fed -- such as credit cards and mortgages -- but isn't expected to siphon off supervision of investment products such as mutual funds from the SEC.

Mr. Obama will call for several requirements to be adopted globally, such as tougher capital requirements for the largest financial institutions and the power to wind down large, globally interconnected banks. Administration officials also are calling for more transparency over complex derivatives that are traded by large, multinational companies.

"Risk and leverage will always tend to migrate to where the constraints are weakest," Mr. Geithner said Saturday after a meeting in Italy of finance ministers from the Group of Eight major powers. "We need a level playing field globally, or the effectiveness of our national safeguards against risk will be undermined."

House Financial Services Committee Chairman Barney Frank (D., Mass.) is expected to take up the measure on Capitol Hill soon and could have a comprehensive package passed by August. Senate Banking Committee Chairman Christopher Dodd (D., Conn.) said his panel could hold votes in the fall with a final measure completed by the end of the year. That is consistent with the administration's timetable.

Write to Damian Paletta at damian.paletta@wsj.com