When you enact economic policy legislation, setting the effective date is very important.  Usually, you want to avoid a rush to market by the first to hear while you're in the middle of legislating, so you choose the date of the first public announcement.  Often you set the date of enactment, when the president signs the bill into law because only then is it certain the law will be put in place.   Retroactive effective dates are a no-no, because they trap people without warning, particularly tax increases on activities that have already occurred.  Sometimes you set a future effective date to allow those affected time to comply.  That was the thinking behind the Expedited CARD Reform for Consumers Act of 2009 that President Obama signed into law on May 22, 2009 with effective dates in February and August of next year.  However, banks are using the interim to jack up credit card interest rates.

We will get more information today on whether the government is planning to institutionalize bailout in lieu of bankruptcy.  At 9 o'clock, the House Committee on Financial services will hold a hearing on systemic risk and resolution issues.  You can find the prepared testimonies and watch it here.  The lineup includes Paul Volcker, Arthur Levitt, Jeff Miron, Mark Zandi, and John Cochrane.

I think most of the discussion of a "systemic risk regulator" has so far been misguided.  I am very skeptical of how it would work in practice.  How does that meeting between the regulators and an individual bank go?  "So, in conclusion, while we find nothing wrong in your risk profile per se, we have observed systemwide too much leverage, so we are going to require your bank to restrict its lending at the margin?"  Or how about, "While you haven't done anything wrong yet, we think that if you continue to compete so aggressively for loans, you will endanger your competitors.  So back off."  If the regulatory process could work well enough to do that, it certainly would have worked better up until now.

The White House couldn't let the one year anniversary of the fall of Lehman go by without it being "celebrated."  At the very least the president had to say that things are much better now -- and they are -- than they were a year ago.  He also had to say something to demonstrate to (please forgive me for using this phrase) "Main Street" that he knows it's still not happy.

But the real purpose of the speech was to refocus the financial services reform debate in Washington.  The president may have been speaking to Wall Street executives, but the real audience was members of Congress, especially Democrats, some of who in the next few weeks will be marking up various pieces of financial services regulation legislation.  He had to show that the general issue hasn't gotten lost in the health care debate and to say that the effort is still needed even if things seem to be better ("Normalcy cannot lead to complacency").

Immediately after the speech, the discussion on CNBC -- the financial channel that thinks it talks to and sometimes for Wall Street -- focused more on how what the president proposed could be implemented rather than whether it was needed.

This idea by Jeremy Bulow and Paul Klemperer is still the best one I've seen for how to reorganize the banking sector without massive infusions of taxpayer dollars.  (See this earlier description).  Here is the summary:

1. We cannot efficiently value or transfer “toxic” assets - so a good plan cannot depend upon this.
2. The UK’s Special Resolution Regime, or one similar to that of the US FDIC, can cleanly split off the key banking functions into a new "bridge" bank, leaving liabilities behind in an "old” bank, thus also removing creditors’ bargaining power.
3. Creditors left behind in the old bank can be fairly compensated by giving them the equity in the new bank.
4. We can pick and choose which creditors we wish to “top up” beyond this level, but should not indiscriminately make all creditors completely whole as in recent bailouts.
5. Coordinating actions with other countries will reduce any risks.

The key point is the first one -- too much of the Obama Administration's plan is focused on so-called "toxic assets."  Risky assets should be held by equity holders -- they should not be held by the government, nor should the government be subsidizing their purchase.  These distressed institutions already have equity holders.  What is needed is simply a mechanism to match the insured liabilities with the highest quality assets.  This is such as mechanism.

Susan Woodward and Bob Hall illustrate nicely how a partitioning of an existing bank into a good bank and a bad bank could work.  The key is that the good bank is a wholly owned subsidiary of the bad bank.  The good bank holds the insured deposits of the current bank, along with all of the assets of sufficiently high quality.  The bad bank holds the liabilities other than the deposits and owns the remaining assets and all of the equity in the good bank.  Here is how they describe the rationale for making the partition:

Is it really possible that the Wall Street community doesn't understand how much its world has changed in the past six months?

I have to ask this question after reading the weekend accounts about how surprised and angry Wall Street is about the extremely negative public response to the story about the million dollars John Thain spent decorating his office.  It apparently is also shocked at the even more negative reaction to the very large bonues Merrill paid its staff last year at the same time the company needed a taxpayer bailout.

CNBC spent much of last Friday defending the decorating and bonuses.  It's on-air personalities called the decorations an insignificant amount of money and said that the bonuses were just a fact of life on the street.  Former General Electric CEO Jack Welch said on Squawk Box that the bonuses were the way to keep good people and make it more likely that the companies the federal government has invested in will do well.

Your Sunday required reading this week comes from Professor Lasse Heje Pederson of NYU, courtesy of VoxEU, "Understanding Liquidity Risk and the Current Crisis."  Jumping straight to the conclusions:

If the problem is a liquidity spiral, we must improve the funding liquidity of the main players in the market, namely the banks. Hence, banks must be recapitalised by raising new capital, diluting old equity, possibly reducing face value of old debt. This can be done with quick resolution bankruptcy for institutions with systemic risk, i.e. those causing liquidity spirals.

Further, we must improve funding markets and trust by broadening bank guarantees, opening the Fed's discount window broadly (giving collateralised funding with reasonable margins), and ensuring the Commercial Paper market function. Further, risk management must acknowledge systemic risk due to liquidity spirals and the regulations must consider the system as a whole, as opposed to each institution in isolation.

Apparently, the Fed is the place to be on the weekend in the late summer.  Released just two hours ago:

The Federal Reserve Board on Sunday approved, pending a statutory five-day antitrust waiting period, the applications of Goldman Sachs and Morgan Stanley to become bank holding companies. 

Pete started this. Let me add a few quick thoughts.

I'm a big CNBC fan, but the way they covered the Treasury secretary's formal announcement yesterday of a financial services reform plan after a weekend of informal releases was close to yellow journalism. Not only was there little new to report by the time Secretary Paulson stepped up the microphone, by then it was also clear that this was not going to be adopted this year, or perhaps ever.

First, you had a major proposal by a lame duck administration with very low approval ratings facing a hostile House and Senate controlled by a different political party.

Second, you had a very contententious plan that even its supporters agree won't do much to deal with the current situation before Election Day.