Commentary

Financial Regulation’s New Drapes

Not many in this country saw the financial crisis coming. Those who did were tarred as foolish and behind the times. Millions of Americans were becoming obscenely rich just by breathing as the credit and housing bubbles grew to monstrous proportions. Why question a good thing? That seemed to be the predominant refrain of the day. Now, after the credit bubble finally burst, the banking sector, which acted as a billow fueling the flames of indulgence, is on its knees, trying desperately to repair the damage wrought by the worst financial crisis in decades. And those in Washington DC, who were awake only enough to collect campaign contributions and regulatory fees, are deciding the future of the financial regulatory landscape.

In the aftermath of the biggest orgy of consumption the world has ever witnessed and the near collapse of global finance last fall, angry fingers of blame quickly rose, stiffened with righteousness, and pointed in directions steered by convenience, as opposed to fact. The accusations still being cast about are often misguided, and the true causes for this financial catastrophe are too widespread and complex to be uncovered, much less understood, so soon after the crisis struck. The truly unfortunate fact is that the perpetrators and beneficiaries are still at the helm of both the economy’s recovery and the financial market’s regulatory reform; it is no surprise that the remedies proposed to repair the damage will amount to little more than window dressing. It is the misguided, and potentially harmful approach to the restructuring of financial regulation that I will discuss today.

Last week, I stated my opposition to granting the Federal Reserve unchecked power to resolve the next financial crisis. But, there is an even bigger problem that is not being addressed by the Obama administration as it seeks regulatory overhaul of the financial system. The creation of a consumer protection agency, a national bank supervisor and a council of financial regulators can be helpful in preventing the next banking crisis. But, as Richard A. Posner, who is a judge on the U.S. Court of Appeals for the Seventh Circuit, pointed out in a NY Times op-ed piece this week, it is the regulators’ culture and their funding sources that needs to change.

Posnner criticizes the bureaucratic and political culture that prevents proactive responses to looming disasters:

“Adding bureaucratic layers will not cure the pathologies of regulation, which are rooted in our regulatory culture — the timidity of civil servants, the contamination of public administration by politics and interest groups, and the power of the “office consensus” to marginalize independent thinkers for not being team players.”

It is painfully evident that selfish interests, paid for by those who are the subject of regulation, will find their way into the halls of Congress, stifling any attempts at true reform emanating from both new and existing agencies. And, once a regulatory agency is established, it will become a bureaucracy, more interested in survival than the actual performance of its mandates.

Another problem, which may be even more damaging, is that there is no plan to change the funding for existing financial regulatory agencies. Right now, these agencies are paid fees by the companies they are charged with overseeing.

Posner describes this problem as well:

“The current system makes the firms customers rather than wards and incites competition among agencies for clients — a competition likely to be won by the agency with the least regulatory zeal.”

And, he offers a potential remedy to this dilemma, which I think is a step in the right direction:

“Another possibility would be to finance regulatory agencies by Congressional appropriation rather than by fees paid by the firms they oversee.”

This funding structure allowed many banks and mortgage lenders to seek the weak oversight of the Office of Thrift Supervision (OTS). This agency, like so many others in the federal government, survived on fees charged to the companies that it regulated. According to an article in this week’s New Yorker, written by Connie Black. failed companies like Countrywide Financial and Washington Mutual were courted by the OTS. Although the OTS is expected to be folded up and tucked into the Office of the Comptroller of the Currency, the same type of “client shopping” could occur again in one of the remaining regulatory agencies.

The financial crisis and resulting recession could have been prevented. Pointing fingers when so many are to blame serves no identifiable purpose. An honest and far-reaching appraisal of what caused the credit and housing bubbles is the only thing that will help determine what to do in order to prevent another financial calamity. Unfortunately, that is not happening. Instead, those responsible for the mess are being paid handsomely, with taxpayer dollars, to clean it up and make sure that it doesn’t happen again. The Obama administration’s attempt to change the nature of financial regulation does much more to entrench the existing corrupt culture than it does to bring true reform to a regulatory system suffering from complete dysfunction.

Here are a few articles that will help will help sort out what’s happening to America’s financial markets after the bursting of the credit bubble:

“Battle Is Brewing Over Watchdogs”, from The New York Times.

“Hedge Funds Step Up Efforts to Avert Tougher Rules”, also from the Times.

“Broad Agreement Reached on Derivative Oversight”, from The Washington Post.

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