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One Regulator to Rule Them All?

Yesterday, The Post reported that the administration is considering a plan to centralize banking regulation in a single agency:

The new regulator would assume responsibility for the safety and soundness of banks, currently divided among the Fed and three other agencies: the Office of the Comptroller of the Currency, the Office of Thrift Supervision and the Federal Deposit Insurance Corp. The OCC and the OTS would probably disappear, while the Fed and the FDIC would retain other responsibilities

The ultimate lineup, it looks like, will include: the Federal Reserve, now responsible for systemic risk regulation as well as monetary policy; a new regulator for all banks; the FDIC, perhaps reduced to the role of managing the deposit insurance fund itself (or perhaps the FDIC will become the central bank regulator); and a combination of the Securities and Exchange Commission and the Commodity Futures Trading Commission, now responsible for securities and derivatives.

Keep an eye on our new series, "Making Financial Regulation Work," for many more opinions on these topics.

This attempt to consolidate regulatory agencies is well-intentioned, and no doubt a good thing. The current system, where complex financial institutions can select among multiple regulators, clearly results in regulatory loopholes (think AIG). However, it skirts some of the central issues that must be faced in a new regulatory system.

One principle that has been floated is the idea that regulation should focus on financial functions, not financial institutions. The idea is that anyone who, for example, enters into a derivative contract should be regulated the same way; it should not matter if you are a bank, an insurance company, a hedge fund, or a mutual fund. Otherwise you have two problems: first, the activity you want to regulate can escape oversight by migrating toward a new type of unregulated institution (like a hedge fund); second, companies can gain competitive advantages based on their institutional format. Having a single regulator for all banks is an improvement, but does not address the distinctions between banks and hedge funds.

Another issue that is not addressed by reorganizing regulatory issues is that of size. A major contributor to the current crisis - and to the need for large and unpopular bailouts - was the fact that several financial institutions grew "too big to fail." In addition to better regulation of what banks do, there needs to be regulation of how big banks can become. As a basic principle, it is better to assume that regulation, no matter how well designed, is bound to fail, and therefore it is important to minimize the potential damage caused by failure.

More fundamentally, our regulatory system needs to address the very real problem of regulatory capture. No regulatory agency can do its job appropriately if the people who man that agency adopt the beliefs and objectives of the firms being regulated. Centralizing authority in a single agency may just increase the incentives of the industry to capture that agency.

The administration has not announced its full regulatory proposal yet, and the news accounts we hear from day to day may be the product of conscious leaks to test public opinion about various facets of the plan. So it is very possible that these ideas are being considered and will be addressed in the final plan. Without them, however, we risk a long, drawn-out battle over power between multiple agencies (remember the creation of Homeland Security?) without the benefits of a fundamental overhaul of the regulatory system.

By James Kwak  |  May 29, 2009; 1:13 PM ET
 
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Comments

That would be perfect. A one-stop shop for lobbyists.

Posted by: msgnet | May 29, 2009 2:19 PM | Report abuse

We note that on June 18, 1998, in a letter to Betsy White, Senior Vice President at the NY Fed, we said:

"..it is our continuing belief that the Federal Reserve Board should be designated a 'Superregulator,' with broad responsibility for overseeing the activities of banks, thrifts, pension funds, insurance companies, mutual fund companies, brokerage firms and investment banks. We note our belief that financial institution convergence, driven by recent advancements in financial and computer technology, requires the creation of such a 'Super-regulator.' "

We, and others, no longer believe the Federal Reserve independent or objective enough to serve as "Superregulator" or as "Systemic Regulator." They are, thus, unqualified for the role.

This role should be filled by an entirely new entity.

See: http://twisri.blogspot.com/2009/03/treasury-outlines-framework-for.html

http://twisri.blogspot.com/2009/04/adam-smith-on-current-financial-crisis.html

http://twisri.blogspot.com/2008/11/what-we-said.html

Posted by: billycdc | May 29, 2009 6:34 PM | Report abuse

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