Still broken

Meet our new regulatory structure, almost as bad as the old one.

By David Andrew Singer

Last week, the administration of U.S. President Barack Obama released a wide-ranging plan to reform the regulation of financial institutions and markets. Pundits and economists, pleased by the attempt to control “too big to fail” institutions and systemic risk, met the plan with guarded caution.

Harsher criticism would have been warranted. The proposal falls short, as it fails to address a crucial problem: the United States’ fragmented, and thus broken, financial regulatory structure. Indeed, rather than emulating the world’s best regulatory systems — which are streamlined and unitary, like Canada’s — the United States has simply dusted off its current Balkanized system and tried to pass it off as new. American companies and investors deserve better.

Of course, Obama’s proposal includes many sensible reforms. For example, all nationally chartered banks would be supervised by a new national bank supervisor, rather than multiple agencies. Financial holding companies would be subject to strict capital and other prudential standards, thereby closing the loophole that AIG, Bear Stearns, and other institutions exploited for enormous financial gain (but which ultimately led to their downfall). And hedge funds and other private pools of capital would have to register with the Securities and Exchange Commission (SEC) and open themselves to monitoring.

However, as the biggest regulatory overhaul since the Great Depression, the proposal leaves much to be desired. It would abolish just one regulatory agency — the Office of Thrift Supervision (OTS). Accountability for financial stability, whether of individual firms or the entire system, would continue to be spread thinly across the Federal Reserve, Treasury Department, and an alphabet soup of bank, securities, and insurance regulators.

The national bank supervisor would not have jurisdiction over thousands of state-chartered banks, which could still choose to be regulated by either the Federal Deposit Insurance Corporation (FDIC) or the Fed. Fifty separate state regulators would still oversee insurance companies, with only a new token Office of National Insurance to “coordinate” their disparate regulatory regimes. The Commodity Futures Trading Commission and the SEC would remain institutionally separate, despite the clear overlap in their jurisdictions. Complex financial institutions such as Bank of America would continue to face a multitude of masters, including the new national bank supervisor, the Fed, and the SEC.

This regulatory hodgepodge inevitably creates loopholes to be exploited. In the past, banks and other financial institutions have been able to to play regulators off one another. For instance, in 2007 OTS actually courted Countrywide Financial away from another agency by offering more-flexible oversight. There’s too little in the Obama proposal that promises to stop such malfeasance.

Another troubling part of Obama’s proposal is the creation of a Financial Services Oversight Council to “identify emerging systemic risks and improve interagency cooperation.” In place of regulatory consolidation, the new council would give the full gamut of regulators a seat at the table and no doubt invite the very turf wars and blame shifting that contributed to the financial crisis. The need for such a council reflects the underlying fragmentation that should be rectified — and not by committee.

The United States has much to learn from other rich countries — Australia, Canada, Finland, and South Korea, for instance — that have simplified their regulatory structures. Financial institutions in these places, from the largest holding company all the way down to the smallest subsidiary, have a single regulator. Requirements are clearer and better enforced as a result.

Moreover, central banks in these countries are focused solely on keeping prices stable and monitoring systemic risks. The Fed currently has a dizzying array of responsibilities, from administering the White House’s distressed-asset programs to determining if a company is overleveraged. It is difficult to imagine it will succeed, particularly with other Balkanized agencies muddying the waters.

The time has come for the United States to rationalize its regulatory structure by simplifying it. The rest of the world is waiting.

David Andrew Singer is assistant professor of political science at the Massachusetts Institute of Technology. He is the author of

Regulating Capital: Setting Standards for the International Financial System

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