The Prince is eagerly looking forward to Treasury Secretary Paulson’s speech scheduled today. As many readers know, the Prince has taken a keen interest in trying to predict and follow the regulation that is sure to come for investment banks. How ironic that someone who led the most storied Wall Street firm and underwent the most severe arm twisting to force his acceptance of the Treasury job has become the bearer of bad news for Wall Street.

In fact, the Prince has argued that his old firm, which is a highly levered large trading book bank, will be most harmed by regulation that is most certainly coming. Paulson is likely to call for expedited changes to the status-quo regulatory framework that would allow the government to intervene more in the functioning of markets. It is not bad enough that he has to propose reforms that will lower risk taking and therefore limit profitability he has to go and argue for such regulation to get functioning sooner.

The Prince is sure that his Wall Street brethren were hoping that usual paralysis in Washington would allow this period of turmoil to pass without new regulation before the next boom cycle begins. Yet, the again maybe it takes an industry veteren like Paulson to force the investment banking industry to swallow the bitter medicine it may need. Will Paulson’s proposals lower systematic risk and the probability of another Bear Stearns? Yes. Is this good for the average person in the United States and the world financial system’s stability? Yes. Are the proposals going to seriously and forcibly cut investment banks’ profitability and risk-appetite? Yes. Is everyone on Wall Street going to hate the new regulation? You can answer that one.

Some excerpts from the WSJ of pretty scary stuff for banker’s:

The Fed and Securities and Exchange Commission, which currently has oversight of investment banks, are working on a formal memorandum of understanding to guide their joint oversight of investment banks. The Fed already has staff members on site at the brokerage firms. Its temporary lending facility is expected to expire in September.

Top Washington regulators have been grappling with questions about the structure of financial regulation since the near-collapse of Bear Stearns. Wednesday, Federal Deposit Insurance Corp. Chairman Sheila Bair, said in a speech that banking regulators need to consider much broader regulation of investment banks — including possible receivership if a large firm fails.

She said it is no longer unthinkable that a large commercial or investment bank will fail, and the federal government cannot “simply write a blank check” when firms like Bear Stearns get in trouble.

Supervisors also need to be able to take prompt corrective action with investment banks, Ms. Bair said, allowing for intervention and potential closure if a firm presents a serious risk to the broader economy.

Posted in Categories: Contributor, Economy, External Research.

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