Imagine the perfect financial regulatory agency. Such an agency could only continue to be perfect if nothing ever changed or if it could always anticipate every possible move by people wishing to exploit the deficiencies in the regulatory system instantaneously and it would allocate capital where it was needed without friction and instantaneously. Now read David Dayen’s remarks on “rationalizing” financial regulation:
The truth is that, regardless of what you think of the Dodd-Frank reform law, the financial regulatory system we have is incredibly unintelligently designed. Overlapping responsibilities, an alphabet soup of agencies zealously guarding their jurisdictions and a lack of a clear hierarchy has created such a morass that major problems can easily fall through the gaps. Think of the worst organizational chart you can imagine — like the one for Initech, the fictional company from Office Space, where Peter Gibbons has eight different bosses — and make it a little worse, and that’s what our financial regulatory apparatus looks like. Nobody would start from scratch and design oversight this way.
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This process of rationalization has some key features:
• The Financial Stability Oversight Council (FSOC) would get new independence as a super-regulator with broad oversight authority of the entire system. The Office of Financial Research would similarly get shifted out of the Treasury Department and have its own data collection mandate.
• A new Prudential Supervisory Agency (PSA) would be responsible for the supervisory authority now stretched across five different federal agencies, examining banks, systemically important financial institutions (SIFIs), investment dealers, money market funds and more.
• The Federal Reserve would do rulemaking, but the PSA could propose regulations for them to approve. It would also have some oversight authority in concert with the FSOC.
• The Federal Deposit Insurance Commission would focus on deposit insurance and orderly liquidation of failed firms and get out of the primary supervision business.
• The Office of the Comptroller of the Currency, which currently regulates nationally chartered banks, would be eliminated.
• The SEC and the Commodity Futures Trading Commission would be combined into one regulator with responsibility for investor protection and capital market conduct.
Some random observations about Mr. Dayen’s preferred “rationalization”. It would be most effective the first day it opened its door and would deteriorate over time. How do I know that? We’ve been studying bureaucracies for the last 150 years and one of the things we know about them is that over time they stray from their notional mandate and devote increasingly more time, attention, and resources to organizational purposes. Note, too, that in the world Mr. Dayen envisions regulators are never coopted by the institutions they’re supposed to be regulating (“regulatory capture”) but always devote themselves unswervingly to their mandates. Regulatory capture of financial regulatory agencies is so obvious as to hardly require additional proof.
I’ve quoted the testimony around here before on the sources of the financial crisis. It wasn’t that no one had the authority to rein in the excesses or that the structure of regulation was too complicated. It was that the agencies with the mandates and authority didn’t bother to do their jobs.
In actuality there is a perfect financial regulatory agency along the lines I described in the opening paragraph of this post. It’s called “the market”. Like Christianity or communism the market is not a case of having been tried and found wanting but of having been found difficult and not tried. We do not presently have a market system and have not for at least the last century. We have a hybrid system and it’s not working very well.
What will inevitably happen with any regulatory agency, agencies, or structure is that their every move will be matched by the cleverest people in the world who have every incentive to do so to wring a buck out of the nooks and crannies of the system. More complicated even more adaptive structures can’t hope to match that. The only possible opposing force to an emerging phenomenon is another emerging phenomenon.
The reason for the overlapping jurisdictions is because of the agencies primary functions. Since the FDIC is funded by the insured banks, it is beneficial to all the banks that they not insuring insolvent banks.
Much of the problems stem from the assumption that bad behavior can be allowed as long as the worst types are regulated. If Dodd-Frank were a fire code, it would allow the most flammable buildings to be built as long as they had a sprinkler system and fire extinguishers.
The FDIC is a good start, but there needs to be another agency determining the solvency of banks. Otherwise, the FDIC will become subject to regulatory capture. An opposing agency with the incentive to find as many insolvent banks as possible should make the official decision.
A market based solution would have the same problem of becoming captured. In many cases, people do not have enough information to make a proper informed choice, and in others, they do not have enough knowledge to know how to use the information to make a proper informed choice.
There is also a time factor. If I am staying overnight in a city, I do not have time to research which restaurants are least likely to kill me, best tasting, and reasonably priced. With a health certificate, I know I should not get sick or die eating the food.
Regulations are not a “chicken or the egg” question. We know that regulations did not come first. They were the result of business doing whatever they liked because they were too big for the little guy to fight. Regulations were the little guy’s answer, and if businesses had not been shitting on anything and everything, regulations would never have come about.
In many cases, they do go overboard, but businesses brought this upon themselves. So, excuse me if I am not very sympathetic to the sad violin music being played by the conservatives, libertarians, and Republicans.
I think it’s actually a little more complicated than that. The FDIC wasn’t put into place to protect the customers of banks. It was put into place to protect banks. The way it functions encourages banks to take more risks so, consequently, they take more risks.
Basically, you can’t create a more secure financial system by subsidizing insecurity yet that’s what we’re doing.
In my view we need to change our view of regulation in the direction of moderating the effects and away from micromanagement which is an entirely Fordist notion that should have been buried in the last quarter of the twentieth century.
Not unrelated:
Record corporate profits? Actually, those are ‘made-up, phony numbers’
Which reminds me of a joke.
Add backs and “one time” adjustments have always been with us but are truly being abused recently. I’d suggest to you that perhaps only 20% of them should be add backs or one time.
One of the worst abuses has been use of equity compensation, a more recent tactic. Just because a balance sheet item is adjusted doesn’t mean the P&L shouldn’t reflect compensation expense.
The FDIC was put in place to stop the bank runs, but in return, the bank had to subject itself to FDIC rules. At one time there were non-FDIC banks.
For agencies like the EPA, they should have to submit their rules to congress and the president, and they should be processed as any other law. While the politicians are as susceptible to capture, they can be unelected. I would require the laws to have sunset provisions in 10 years.
Canada (!) has recently enacted a new law requiring that before adding any additional regulations an old regulation of equal cost must first be eliminated.