Creation of a superagency to regulate banks is a beguilingly simple idea. Sen. Christopher Dodd, D-Conn., chairman of the Senate Banking Committee, recently sent up a trial balloon, giving the idea new life.
Proponents argue that "regulatory arbitrage" (i.e., shopping for the most lenient regulator) was a significant contributor to the current financial crisis — a thesis not supported by the facts.
The current crisis emanated from unregulated nonbank financial institutions. Moreover, federal bank regulators do not allow institutions to switch charters if they have material open issues with their existing regulator.
The United Kingdom consolidated regulation of all financial services firms into the Financial Services Authority a decade ago. This did nothing to spare British financial institutions in the current financial crisis.
The most efficient and powerful financial regulatory authority our country has ever seen was the former Federal Home Loan Bank Board. The Bank Board had the combined authorities of the Office of the Comptroller of the Currency, the Federal Reserve and the Federal Deposit Insurance Corp. under its wing. Yet the Bank Board oversaw the collapse of the S&L industry and the Federal Savings and Loan Insurance Corp., which cost taxpayers $150 billion.
We do not need more concentration of regulatory power and more centralized decision-making, we need more checks and balances and stronger watchdogs. One of the most important reforms we could make is creating an independent Systemic Risk Council.
We also need to strengthen the FDIC. Its board should be reduced from five members to three by eliminating the seats held by the comptroller of the currency and the director of the Office of Thrift Supervision.
Congress recognized the importance of the FDIC's watchdog role in 1991 when it granted the FDIC increased enforcement and examination powers over all banks and thrifts. Unfortunately, in folding the defunct FSLIC into the FDIC, Congress increased the FDIC's board of directors from three to five, two of the members being from the comptroller of the currency and the head of the OTS.
This structure can have a devastating effect on the FDIC when one or more vacancies exist. The FDIC board had two vacancies in 1993, leaving the FDIC in the hands of Acting Chairman Skip Hove, Comptroller of the Currency Eugene Ludwig and the acting head of the OTS Jonathan Fiechter. The comptroller offered a motion requiring the FDIC staff to obtain approval from the primary regulator before examining a national or Fed-member bank or a thrift.
The motion carried, and the FDIC's authority to serve as a watchdog on the system was gutted. The FDIC, with a few brief exceptions, never had a full complement of directors from 1993 until 2004, making it impossible to override the 1993 vote.
Two other changes at the FDIC need to be considered. The first is the procyclical manner in which FDIC premiums are charged.
Another change we need to consider is the limitation put into place in 1991 on the FDIC's use of its emergency authorities. The FDIC today cannot use its emergency authorities unless requested to do so by the secretary of the Treasury, in consultation with the president, and unless the action is also approved by the Fed board.
This restriction weakens the FDIC's ability to respond to crises and politicizes the process. In reality the FDIC, Fed and Treasury always work things out. But if the FDIC cannot act without approval from both the Fed and the Treasury, the FDIC's negotiating hand is severely weakened, which was quite evident during the recent crisis.