The Obama Administration’s re-regulation of the financial industry will accomplish a multitude of things. It will put the so-called ‘shadow’ banking system of hedge funds and bank holding companies under the Federal Reserve Banks’ control, will cause derivatives trading to be done through a clearing house instead of out of sight, and will both raise banks’ capital requirements and amount of their own money in any transaction, among other things.

Above all, it is intended to restore confidence in our financial system. This is coming at the right time, as the Conference Board’s Index of Leading Economic Indicators (LEI) rose 1.2 percent in May, for the first time since 2007. It showed that economic expansion could begin this fall.

The overall purpose of the new era of re-regulation is to prevent another systemic failure as happened last fall when all the credit markets froze at one time.  And we are beginning to see a glimmer of recovery as banks begin to lend again and interest rates are back down to historic lows.

This in turn is restoring consumer confidence and so their spending. The next stage in the recovery cycle will be a real estate rebound. Housing construction, new and existing-home sales have risen of late, so I see a real estate recovery by the end of this year.

Lastly will be the jobs market, which depends a lot on real estate, by the way. The real estate industry powers not only financial services, but professional services, the construction, insurance, and manufacturing sectors as well.

The huge improvement in the Conference Board’s LEI signaled that growth had already begun in some sectors. Stock prices, consumer expectations, a drop in weekly unemployment claims, and manufacturers’ new orders for non-defense goods all contributed to the improvement.

New York Times’ David Brooks had it right in a recent column. Getting the Obama plan through Congress and the vested interests won’t be easy with so many spendthrifts now becoming budget hawks. But his strategy is to get all those interests believing they will be served, and then quickly ramming through legislation before they realize they won’t be getting as much of the pie!

Here’s what is probably doable. Re-regulation will shrink some of the regulatory agencies by getting rid of the Office of Thrift Supervision, charter a new consumer-protection agency to combat the subprime mortgage problem, and require financial institutions to be less leveraged.

Wall Street will fight any new regulations tooth and nail, of course, since it cuts into their profits. Wall Street has always fought regulation and government oversight. But without the Federal Reserve’s ability to fight the busted asset bubbles that got us in so much trouble, we could repeat history.

The Obama Administration’s main problem will be to quiet the deficit hawks, egged on by Wall Streeters, of course, who don’t believe government should be regulating anything. And they will cry inflation because of the government’s stimulus spending. But as the enclosed graph shows, we are in a deflationary spiral at the present, rather than inflation. Only Switzerland’s annual inflation rate is lower of the developed countries.

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It is deflation that is affecting incomes as well as asset prices (such as housing) and business profits. Wall Street has been proved wrong with their attempts to avoid regulation of any kind. So we must stay the course of re-regulation and government stimulus spending until Americans are put back to work and their incomes begin to rise again.

Harlan Green © 2009