Orbital Matters

Saturn Smith
Editor’s Pick
JUNE 18, 2009 4:45PM

Would Fewer Regulators Really Mean More Reform?

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White House PhotoOne day after President Obama announced his new plan for financial regulatory reform, Treasury Secretary Tim Geithner was on the Hill today, testifying -- in the church sense -- about the administration's new plan.  The plan is unpopular with just about everyone.  Democrats like Senator Chris Dodd and Sen. Chuck Schumer don't like it because it proposes, basically, to beef up the current, multi-regulator system instead of consolidating regulators.  Republicans don't like it because it's a Democrat proposal.  And on and on and on. 

The administration's proposal for reform -- it's about 90 pages and it's available at Treasury.gov -- can pretty much be summarized as "take the current system and add a new layer or two."  It proposes creating a Financial Services Oversight Council to increase coordination among the major financial regulators that already exist, consolidates the Office of Thrift Supervision and the Office of the Comptroller of the Currency into the new National Bank Supervisor office.  And it hands the Federal Reserve a lot of expanded power to observe and regulate.

In short, the plan is Status Quo Plus.  Plenty of financial bloggers and writers were hoping for a dissolution of the current system and replacement with a toothy, single regulator, and Simon Johnson goes so far as to say that the administration's plan will lead to the next major financial crisis.

I'm not convinced that a single regulator would be the way to go.  One of the major problems of this most recent collapse has certainly been the toothlessness of the current regulators, who banks chose precisely because they seemed so unlikely to be strict.  Where there's been overlap between regulators, both sides seem to have thrown up their hands and said, "Not my problem!", leaving banks to make up their own rules.  And where there have been gaps, no one's been willing to step over their own lines to point out the problems.  Essentially, it's been like a Wild Wall Street West where the U.S. Marshals and the town sheriff get into a jurisdiction dispute and let the bandits burn down the jail while they're busy squabbling.

So -- why would going to a single regulator be a better plan?  One of the major problems with the financial system has been regulatory capture.  Some offices get funding depending on how many banks they oversee, and all offices get expanded influence depending on who they deal with, so it's in their interests to attract new supervisees.  If we went to a single regulator, that incentive would be reduced -- but the regulator would still be beholden to Congress for funding, staffing, and probably regular reporting, and Congress, as has been well documented, isn't exactly racing out to propose new, greater regulations on the banking industry.  In fact, if we had a single regulator, wouldn't it be easier for the banks to buy it up?

I'm really curious -- what's to say that a single regulator, the devil we don't know, would be less likely to be captured than the proposed souping up of the complicated, highly political, constantly competitive and clashing system we have now? 

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I think the regulation thing as a panacea is oversold, not just because of the capture thing, but more fundamentally because the busy beaver financial engineers engineer their way around the regulations because people are not, as in neoclassical economics, fully rational at all, but are emotional short sighted and greedy, so there is a limit to how much you can prevent.
And the devil you know, too many regulators passing the buck, could be seen in retrospect as way better than one regulator blowing the entire thing. good discussion.
Whatever form the regulation takes, like lobbyists to the cash cow of vested interest, the workaround specialists at the major institutions will be a step ahead. It will be Status Quo Plus Look Over There a Bunny.
What good is it to overhaul any regulatory enforcement systems when we haven't even overhauled the regulations?

"...busy beaver financial engineers engineer their way around the regulations because people are not, as in neoclassical economics, fully rational at all, but are emotional short sighted and greedy, so there is a limit to how much you can prevent."
The regulatory structure is irrelevant. There is such a thing as "working smarter, not harder" though. What matters is that the structure is created with intelligence and foresight and has an understanding of not only our markets but those abroad. Also, nothing works without people in place who have a sense of integrity.

Of course, only a total frickin' idiot thinks any of things is going to happen :) Obama does not have the courage of his convictions - and neither do we as a country.
Dear OS editors:

It's FEWER regulators, just like in Saturn's title. Sheesharoni!

Ok, now I can go read the post.
great question...I also wish the Democratic party would take on the Republicans for what really happens under Republican political leadership: the defunding (and therefore de-toothing) of all regulatory offices and the refusal to punish companies who don't obey the existing laws.

Many regulatory offices (as I understand it) are funded by the institutions they regulate (conflict of interest?) and they are funded more depending on how many banks or services they oversee. The days of objective oversight seem to be gone, but just as importantly if political leadership of the moment decides not to enforce existing laws, (as happend under Bush) if that party takes power again, what good will more laws do? Not so much good I think.
There is a defense of multiplicity of regulators in the long run,which is similar in character to one version of the defense of federalism, and is outlined in the wonderful book Bureaucracy by James Q Wilson, which is that multiple centers of power, although disliked by the centralizers of power, prevent total system failure, not a trivial risk in an fractional reserve banking system addicted to leverage like the ours.
I have to confess too much ignorance about this matter to speak intelligently to the specifics. In general terms, though, it seems that the overriding issue here, once again, is the influence of money within our government. I think until we address that issue and move significantly in a direction that removes that infectious agent, nothing much will ever change.

The old saying, "too many cooks spoil the broth" might be relevant here, in that there may be too many regulatory "agencies" and simply not enough regulation by those agencies. That seems to be one of the issues raised in your post, Saturn. Too many sheriffs, so to speak, and as you point out, while they squabble of jurisdiction, too little regulating occurs.

One factor no one's talking much about is the regulators themselves -- the people. You can have the best organizational structure and best regulations, but all of that can be undermined by having the wrong people in charge.

Good people in regulatory positions have their own culture; they think about things a certain way. They take time to connect the dots. They pay attention to the details. They are interested even in small anomalies. They aren't golfing buddies with the people they regulate, and they don't plan on using their regulatory experience as a brief career path into the regulated industries.

It's just like in any organization -- you can have policies, procedures, codes of conduct, internal audit, compliance officers, etc., etc., but if the people in charge have the wrong mindset all of the other stuff is meaningless.
I meant to say de-fanged instead of de-toothed...(although it's a terrible thought: gummy regulators....)
A regulatory dictatorship isn't the answer :
How Dare You Want To Know What "Your" Government Is Doing!


Regulation is the problem. Contrary to MSM hooey regulation of the financial sector increased under Bush:

Bush's Regulatory Kiss-Off
Obama's assertions to the contrary, the 43rd president was the biggest regulator since Nixon.


The failure here has been the failure of govt. More regulation is like trying to put out a fire with gasoline. It only will make things worse.
Mishima, great point, which leads me to another flaw in the current discussions of these agencies -- we tend to focus on the bodies as whole, homogeneous actors with single goals instead of as complicated businesses with individual actors within. We hear a lot about Tim Geithner, Sheila Bair, Ben Bernanke, but much less about the people on the front lines who have to actually report and make the reports. It'd be interesting to do a study of promotion within the regulatory side of the financial markets to see how people best move ahead -- by being productive workers (probably not), by having Congressional friends (likely), or by working closely with industry leaders.
We don't need more regulators that don't regulate. What would be welcome is more prosecutions and heavier penalties for banksters who violated existing law. And if the kind of thing that went on at AIGFP isn't illegal or prosecutable, than we need more laws that do criminalize AND punish that kind of financial responsibility.

We can no longer afford the delusion that these are somehow victimless crimes. The days are long gone -- or should be -- when financial markets were considered a game for wolves, and nobody cared if they ate each other.

More on the subject:

I agree, Tom -- but that's on Congress, which was part of Geithner's point. So far, Congress hasn't taken any initiative with the whole problem of regulation, in part because they seem to believe they're at no fault. To admit that legislative reform is needed, they'd have to admit they were wrong from the get-go, and... I doubt we see that happen.
I'm torn about Obama's proposed regulatory system. There's good arguments for giving the Fed more power over the financial system as a whole, creating a consumer watchdog agency, and doing the kinds of consolidation they're talking about.

But the corporate culture of the financial institutions really needed to be blown up and I don't see that happening here. So, I'm also disappointed.
I don't know why everyone is so enthusiastic about the Fed getting more power when they have totally missed the last two asset price bubbles.