WASHINGTON — Before the Obama administration even unveiled its plan to overhaul financial regulation, critics derided it as dead on arrival.
The administration reportedly wants to consolidate prudential oversight of banks into a single agency, hand systemic supervision responsibilities to the Federal Reserve Board and create a financial consumer protection agency.
But House Financial Services Committee Chairman Barney Frank, a crucial administration ally, panned the main idea in an interview Thursday.
"There is no chance of that happening, not even remotely," said Frank, referring to a single prudential regulator. "If you were starting from scratch, maybe, but nobody is going to take bank regulation from the Fed, the FDIC, the OCC and OTS and amalgamate them."
Such reactions undoubtedly will lead the administration to tweak its trial balloon, but regulatory reform is squarely on the radar screen, so we offer the following answers to frequently asked questions.
So the Treasury wants to combine the banking agencies?
Under the Treasury Department's plan, there would be a single prudential supervisor. It would immediately combine the Office of the Comptroller of the Currency and the Office of Thrift Supervision and take on the bank supervisory functions of the Fed and the Federal Deposit Insurance Corp.
The central bank and the FDIC would continue to exist, but they would have other priorities. The central bank would continue to oversee bank holding companies and get additional power to examine systemically important companies. The FDIC would continue to insure deposits and would have the power to unwind banks, their holding companies and systemically important nonbanks.
Sounds simple enough. What's wrong with it?
As Frank suggested, passing it through Congress may be next to impossible anytime soon. Combining the OCC and the OTS would be politically feasible, but stripping the Fed and the FDIC of their day-to-day oversight of state banks is likely to anger community bankers, who worry a single prudential regulator would ignore them in favor of the largest banks under its purview. And the potential to undermine the dual banking system might lead state banking supervisors to oppose the plan.
Wait. How would it undermine the dual banking system?
The Obama administration is expected to argue that the plan keeps the dual banking system intact. According to sources, the new prudential regulator would have two divisions. One would oversee federally chartered banks and thrifts, and one would supervise state-chartered banks. In theory, state regulators would continue to share joint oversight with the newly consolidated regulator.
In practice, however, the situation is problematic. For example, the federal regulator would presumably be preempting state protection laws for some of the banks under its purview while not preempting it for others. From a state-chartered bank's perspective, many view Fed and FDIC oversight combined with state regulation as more community bank-oriented. Those banks may feel there is little value in maintaining a state charter if they are going to be regulated by the same federal regulator as the largest institutions.
Any other drawbacks?
Any attempt to create a single prudential regulator is sure to reopen a debate over preemption — a debate that the OCC, the OTS and the banking industry have won in many court battles. With Democrats controlling both houses of Congress and the White House, it is highly unlikely policymakers would want to grant a new agency the same leeway to preempt state consumer protection laws.
From a large-bank perspective, it's difficult to see what they would gain under the proposal, while they would be risking a critical advantage. Small banks may find a new supervisor more worried about how policy decisions impact large banks. In political terms, there is no natural constituency to support this proposal — and plenty of opponents, including heavyweights like the Fed, the FDIC and community bankers.
So would this system be better than what we have now?
It would be simpler and presumably faster to adjust to problems. After all, sometimes it takes the four regulators years to agree on a single rule or guidance. That said, the rival agencies have provided valuable checks on one another that would disappear if there were only one regulator.
Just look at the Basel II standards. If the Fed had been allowed unchecked authority to do as it pleased, it probably would have removed the leverage ratio and enacted Basel II years ago; critics say that would have resulted in lower capital requirements at some of the largest banks right before the financial crisis hit. As it was, the Fed's plan was vigorously opposed by the FDIC. Implementation was delayed, and the final version is still being reworked.
But some people say charter shopping caused the crisis.
A few banks likely evaded tougher regulation by switching charters, but the practice was hardly common. Honestly, the problem with the financial system appears not to be tied to the structure of oversight, as confusing and complex as it is, but rather to not enforcing standards regulators had on the books. The Fed could have acted sooner to curb abusive mortgage practices, and all four regulators could have done a better job of limiting new products that ultimately posed big problems, like no-documentation loans and option adjustable-rate mortgages.
What about a financial consumer protection agency? How would that work?
That's unclear. It could write rules for consumers and let the single prudential regulator enforce them. Or it could hire its own set of examiners and enforce its standards directly. Alternatively, the consumer agency could set standards on mortgages, for example, and it could enforce those rules against nonbanks but leave enforcement for banks and thrifts to the prudential regulator.
What about systemic risk?
The administration may want systemic risk oversight to reside at the Fed, but this, too, is politically problematic — and Treasury Secretary Tim Geithner knows it. Senate Banking Committee Chairman Chris Dodd, D-Conn., and Sen. Richard Shelby of Alabama, the panel's No. 1 Republican, oppose giving the Fed any additional powers. They have both backed a systemic risk oversight council proposed by FDIC Chairman Sheila Bair, which would share oversight among different agencies.
Even Frank, who had appeared to be leaning toward giving the Fed systemic risk oversight, said Thursday that joint responsibility is the best approach.
"I originally said the Fed," the Massachusetts Democrat said. "I think politically there's going to be a problem with that, and I think some form of group is going to have to do it."
Will any of this pass this year?
It would be very tough for lawmakers to pass a comprehensive regulatory reform package this year, though the Obama administration continues to maintain that doing so is its goal. If anything passes — and that's a big if — it would likely be a bill creating a systemic risk regulator and giving the government the power to resolve "too big to fail" companies. Frank said he planned to pass a bill out of committee by July, with House passage this summer. He will kick off a series of hearings on regulatory reform June 9.
When will we know more?
Look for the administration to release its final plan in the next couple weeks, most likely the week of June 15. Don't be surprised if that plan looks a lot different from what is out there now. The plan, details of which leaked late Wednesday, had the feel of a trial balloon that would let the administration gauge reaction to its proposal before committing to it. The administration's broad agenda will require it to put much of its focus elsewhere, like on health care, so it is hard to imagine it wants to commit substantial resources fighting a tough battle with entrenched interests.