John W. Schoen Senior Producer • Profile • E-mail

The broad regulatory changes proposed by the White House Monday add to an ongoing debate in Washington about what is needed to clean up the mess created by Wall Street’s failure to manage its own risky investments — and keep it from happening again.

With millions of homeowners at risk of losing their homes, Democrats have focused on heading off an expected rise in mortgage defaults — and the resulting losses to investors who bought bonds backed by those now-shaky mortgages. Republicans tend to favor a series of regulatory reforms to streamline the current alphabet soup of agencies created during the Great Depression to rebuild the American dream of homeownership.

Regardless of which approach the government ultimately takes, the most important question is: Can the government can act quickly enough to keep the current credit crunch from spreading?  That part of the story is still being written.

The proposal formally spelled out Monday by Treasury Secretary Hank Paulson was widely reported over the weekend. The goals of the reform would be to improve consumer protections, tighten regulation of some business practices and improve stability of the financial markets. To do that, Paulson proposed giving the Federal Reserve broader powers and more information about investments held by Wall Street brokerages and investment firms.

The hope is that by providing the Fed with more authority to step in and limit investment activity that poses a threat to the financial system, the central bank can act to head off bigger problems down the road.

“That authority at current is limited only to where the Fed identifies a potential systemic, downside risk if they do not act," said Richard Baker, CEO of the Managed Funds Association and former member of the House Finance Services Committee. “It's merely saying, 'We see the train coming.' Today, I have to wait for the train to run over me before I can act. Now we’re going to say, ‘I hear the whistle, I see the steam, I smell the smoke: let's do something before it gets here.’ ”

Though many praised the plan as a step in the right direction, critics argued that it fails to address the more immediate problem of a widening credit crunch that began last summer as the pace of mortgage foreclosures began to rise.

Senate Banking Committee Chairman Christopher Dodd said Monday that the administration blueprint "would do little if anything to alleviate the current crisis."

Dodd and House Financial Service Chairman Barney Frank are working on a bill that would expand the government’s role in helping to refinance mortgages written at the height of the lending boom that have now become unsustainable as house prices have fallen. The White House has opposed measures that would “bail out” borrowers losing their home or the investors who bought securities backed by their mortgages.

But supporters of a government role in refinancing bad mortgages say that approach risks causing wider damage to the economy.

“A million more foreclosures are going to continue to exacerbate this problem," said John Taylor, executive director of the National Community Reinvestment Coalition. "The deterioration of the economy driven by this foreclosure crisis is going to force the hand of something pro active. We can’t go to January of '09 before someone comes into office that’s willing to do something about this.”

Since the financial markets began to come unwound last summer, the government’s primary response has come from the Federal Reserve. After a series of fairly tepid interest rate cuts failed to stem the turmoil, policy makers responded with increasing urgency, culminating in a $30 billion pledge to shore up Bear Stearns after a flight of investor capital pushed the firms to the brink of collapse. 

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