ANALYSIS: Crisis stems from changes years ago

WASHINGTON

Capitalism can't always be trusted. If you are too big to fail, you are too big to make all your own decisions, according to the emerging view in Washington.

Thirty years after President Ronald Reagan started a determined campaign to ease government regulations on business, the pendulum is swinging the other way.

"Too big to fail is the right size to regulate," declares Rep. Al Green, D-Texas.

Riding a wave of public anger over Wall Street greed and government bailouts, the Obama administration presented a far-reaching plan yesterday for "better, tougher, smarter" rules over big financial companies. The plan would crack down on major -- but now lightly regulated -- players, such as hedge funds and traders of exotic financial products.

The administration is also pressing for closer international coordination. Allies want the United States to get tougher, and the new plan will give President Obama something to show when he goes to London next week for an economic summit of 20 major and developing nations.

Much of the regulatory framework now in place dates back to the Great Depression, some back to just after the Civil War.

Most of what Obama is asking for, including a new regulator to oversee the entire financial system, will require legislation. With the level of angst in the country as high as it is, it seems likely he will get at least some of the changes through the Democratic-controlled Congress.

Even critics of the administration acknowledge that there needs to be more financial regulation to avoid any repeat of the kind of meltdown that has plunged much of the world into painful recession. Few would argue that it's a good idea to allow sprawling financial conglomerates to be able to shop for their own regulator -- pretty much what bailed-out insurer American International Group did.

But there is also fear of going too far and suppressing the entrepreneurial spirit that is part of the nation's free-market heritage. The pendulum had been swinging against tough regulation until recently.

Although President Jimmy Carter began deregulation efforts in the late 1970s, focusing on airlines, trucking, railroads and natural gas, Reagan popularized the idea as a major government goal. He imposed a moratorium on all new federal regulation enforcement upon taking office.

Contending that government was the problem, not the solution, to the nation's ills, he persuaded Congress to deregulate many businesses. He spoke of setting free the mighty engine of capitalism. Distinctions between commercial and savings banks were eliminated during his presidency.

President Bill Clinton continued the process, signing legislation ending the 1930s-era barrier between banks and investment and insurance companies, but without subjecting those nonbank institutions to the rules that apply to banks.

In the midst of the current crisis, Sen. Judd Gregg, R-N.H., still says that the government needs to not overregulate "to the point where we wipe out one of our great advantages as a nation, which is that we had folks willing to put money up for people willing to take risk and try to create jobs."

Paul C. Light, a professor of public service at New York University, noted that complex investment products known as derivatives, including mortgage-backed securities, "were once seen as a great innovation and widely celebrated." Their implosion set off the world financial meltdown.

"We want more transparency but we want, at the same time, to protect innovative ideas," Light said. "Everyone's so angry. What the public wants is a radical pendulum swing toward the tightest regulation. We just have to be careful that we don't overdo it."

In any event, Light said, "we're certainly done with the era of self-regulation. That's over."

Supporters of more regulation say they don't want to squelch American entrepreneurship.

"Obviously, no system is going to prevent all failures, because it would then be too restrictive," said Rep. Barney Frank, D-Mass., the chairman of the House Financial Services Committee. The goal is to minimize the likelihood that big financial entities will get so heavily indebted "that their lack of success threatens the whole system," he said.

Another part of the administration's financial-regulation overhaul, presented earlier in the week, would grant the government the power to seize any large failing financial company, a power it now holds only for banks. It also plans to send Congress legislation protecting consumers and eliminating flaws in existing regulations.

Still, Washington always deals with the sins of the past, tries to solve old problems and doesn't have a crystal ball to deal with the future.

Whatever the rules, someone tries to come up with ways to slip around them, sometimes with Washington's help.

Remember: Brooksley E. Born, a former chairwoman of the Commodity Futures Trading Commission, tried in 1997 to impose greater federal rules on derivatives. She was fiercely opposed by Alan Greenspan, then the Federal Reserve chairman, and by Robert Rubin, Clinton's Treasury secretary.

Rubin, now an outside adviser to Obama, says he favors regulating derivatives, particularly increasing reserves against potential losses, but saw no way of doing so while serving as Treasury secretary.

Greenspan says that the problem wasn't with the derivative contracts but with the greed of the people who dealt in them.