There's a new sheriff in town

The new sheriff is a lot different than the old sheriff who, come to think of it, wasn't much of a sheriff at all. Bartender? Yes. Sheriff? No. The town mayor looks pissed.
In this Wall Street Journal story($), Greg Ip fills in some of the details on the proposed financial market regulatory reform that will be formally announced later this morning by Treasury Secretary Paulson.

The Federal Reserve, criticized for regulatory lapses that allegedly aggravated the credit crisis, emerges at first glance as the big winner in Treasury Secretary Henry Paulson's proposed overhaul of financial regulation.

But Mr. Paulson's plan to make the Fed a supercop in charge of keeping the financial system stable is also problematic for the Fed and its chairman, Ben Bernanke. The Fed is being asked to do a job that may be beyond anyone's ability: Identify and avoid a crisis in advance.

"Supervising the very complex derivative products of the banks and of the rest of the financial system would be an enormous technical challenge," said Harvard University economist Martin Feldstein, a prominent Republican adviser who has criticized the Fed's supervision of banks leading up to the current crisis. "The institutions themselves -- paying very high salaries and having their own survival at risk -- got it wrong. Would the Fed get it right?"
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Under the Paulson plan, which is unlikely to be adopted as proposed, the Fed would retain, for now, authority to write consumer-protection rules on things such as credit-card disclosures and the terms of high-cost mortgages -- despite accusations from consumer groups and Democrats that its failure to do so allowed many homeowners to get subprime mortgages they couldn't afford.

In Mr. Paulson's "optimal" scenario, the Fed eventually would surrender its supervision of state-chartered banks and bank-holding companies to the new agency and become a "market stability regulator." The Fed, Mr. Paulson said in an interview Saturday, "would have broad powers so they could go anywhere in the system they needed to go to preserve that authority."

In that role, it would be able to lend to any important institution while seeking information from them, which Mr. Paulson considers more reflective of a financial system spread among brokerages and other nonbanks as well as traditional, commercial banks.

Mr. Paulson had always envisioned this new role for the Fed, but events in the past month, including the near-collapse of Bear Stearns Cos., made it especially germane. For months, Bear Stearns had faced questions about its reliance on short-term funding and heavy exposure to risky mortgage-backed securities. Three weeks ago, other firms and investors suddenly became reluctant to do business with it.

That forced the Federal Reserve Bank of New York to extend Bear Stearns a loan via J.P. Morgan Chase & Co. on March 14, the first such loan in Fed history. On March 16, worried that a similar loss of confidence would engulf other firms, the Fed offered the same access to all investment banks.

Hopefully, included somewhere in the proposal, is a sort of simple, common sense approach to regulating mortgage lenders that would have prevented much of the current housing and credit market mess.

Specifically, that potential homebuyers have some reasonable expectation of paying back the money they borrow out of their income rather than through home price appreciation.