regulators’ analyses should be collated and sifted by a super-regulatory body with the power to head off systemic threats

TO BE NOTED: I've called this Rationalization: From the FT:

"Why the US needs a super-regulator

Published: March 11 2009 20:00 | Last updated: March 11 2009 20:00

Ben Bernanke says we are going to need a bigger boat. The Federal Reserve chairman has suggested a number of reforms to the regulation of US financial services – some of which would probably increase the size of the Fed’s remit. Although politically controversial, his ideas deserve to be followed through.

The US regulatory system is riddled with extreme complexity. Insurance companies’ risks are not monitored in the same way as banks’ are. The resolution regime for insolvent financial institutions varies according to whether or not they have insured depositors. And there is no single institution standing far enough back from the coalface to spot systemic problems.

Last autumn, these small cracks in the regulatory system turned out to be shuddering fault lines. The global importance of Lehman Brothers and AIG was not grasped until it was too late. The risks posed by systemic financial problems to the business models of these companies were overlooked. And the authorities lacked the tools to dismantle failing institutions safely.

Mr Bernanke is right that the US regulatory system needs consolidation. The watchdogs, between them, must understand every part of the companies they are inspecting and a regularised resolution regime for insolvent financial companies is an absolute must. One might add that companies also need to be regulated consistently and according to what they do, rather than what kind of business they are. The US could do with fewer, bigger regulators.

What is more, as Mr Bernanke argues, regulators’ analyses should be collated and sifted by a super-regulatory body with the power to head off systemic threats. Mr Bernanke noted that the Fed would need to be involved with such an agency. In truth, it makes sense to give “macro-prudential” oversight to the Fed; monetary policy, the lender of last resort function and financial stability should all be dovetailed.

This is not simple; the Bank of England has a financial stability remit which it has neglected. In the US, political difficulties make the task yet harder. Insurance is largely regulated on a state-wide basis, but will need to be part of the super-regulator’s remit. Concentrating more power, even power which the federal government wields, in the hands of the already-mighty Fed would also be contentious.

Crucially, consolidation would make it easier for the US to collaborate with other countries to fight cross-border risks. Especially so if recent plans for European cross-border supra-regulators are adopted. No matter how big they are, regulators must work in convoy.

Copyright The Financial Times Limited 2009"

"I'm betting the theory of regulatory competition is going to go on holiday for a few years"

Justin Fox with a post about what I call Rationalization:

"The top West Coast regulator of the Office of Thrift Supervision has been removed from his jobwhile the Treasury Department's inspector general looks into some weirdness surrounding backdated capital infusions into since-failed thrift IndyMac( I POSTED ABOUT THIS STORY ). Add that to the demise of the biggest savings institution regulated by OTS, Washington Mutual, the loan troubles inherited from OTS-regulated Golden West Financial that forced Wachovia into a merger with Wells Fargo, and the various shenanigans associated with OTS-regulated Countrywide Financial, and things really aren't looking good for the agency. Oh, and don't forget AIG, which due to a quirk in our country's deeply quirky regulatory setup was also overseen at the holding company level by OTS( PLEASE. NO MORE ).

The OTS was created as a semi-autonomous division of the Treasury Department 1989, to take over the regulatory duties of the Federal Home Loan Bank Board, which was seen as identifying too closely with the savings and loan industry to do a good job of supervising it( YOU CAN'T BE SERIOUS ). I was the OTS beat writer for American Banker in the mid-1990s, and in those days the agency was trying hard to be professional and just as tough as the other banking regulators. But there was still lots of talk of looking out for the interests of the thrift industry, and ensuring the attractiveness of the federal savings bank charter that OTS oversaw( HOW CHUMMY ).

That's just the natural tendency of any specialized industry regulator, and I'm certainly not going to blame OTS for our current troubles ( I WILL GIVE THEM A TINY PORTION OF BLAME, IN THAT THEY ALLOWED REGULATORY SHOPPING ). The craziest of crazy mortgage lending was done by mortgage brokers selling to Wall Street. The OTS-regulated thrifts mostly just followed( THAT'S ENOUGH FOR BLAME ) in their lead. But OTS didn't stop them, I imagine, because people there were worried about thrifts losing market share( YES ). That, and they had been drinking the same home-prices-never-go-down Koolaid ( I DON'T BUY THIS KOOLAID ) as everyone else in real estate. The regulators were of the industry, not above it( NICE ).

This country's Balkanized financial regulatory structure (just for banks and savings institutions there's the OTS, the OCC, the FDIC, the Federal Reserve, and all the state banking commissioners) is mostly the product of history and bureaucratic turf wars. But for the past few decades there's also been a theory—regulatory competition, it's called—to back it up.

Having different state and federal entities compete for the privilege to regulate a particular company results in more market-friendly regulations, the thinking( THAT'S WHAT IT IS UNTIL THE REAL WORLD COMPLIES ) goes. That may be true, but more market-friendly regulations are also generally weaker regulations( TRUE ), and in the financial sector weak regulations can eventually end up destroying the very markets they're being friendly to. As we've seen lately( I AGREE. SOMETIMES, POORLY ENFORCED REGULATIONS ARE WORSE THAN BOTH ZERO REGULATIONS AND TOUGHER REGULATIONS ).

I'm betting the theory of regulatory competition is going to go on holiday for a few years, maybe decades. The OTS will be among the first victims of the new intellectual climate—Hank Paulson already proposed getting rid of it last spring. Any guesses as to who's next after that?"

I've already said that the whole system needs to be Rationalized. In other words, streamlined.

"If anyone can force a merger of the S.E.C. and the C.F.T.C., she can."

Floyd Norris on the NY Times asks a question on many people's mind:

"Can She Save the S.E.C.?

Mary Schapiro, a veteran and diligent regulator if ever there was one, is reported to be Barack Obama’s choice to head the Securities and Exchange Commission. It is a choice that should please those who hope the S.E.C. can recover from what must be the worst year in its history ( IT MIGHT BE ONE OF THE WORST IN THE HISTORY OF REGULATORS ).

Ms. Schapiro has been around Wall Street regulation for decades. She worked at the Commodities Futures Trading Commission as a staff member in the early 1980s, then became a member of the S.E.C. and chairwoman of the C.F.T.C. She helped clean up Nasdaq and now runs Finra, the industry self-regulator. She has been appointed to jobs by Republicans and Democrats.

She will have to take a leading role in shaping the new regulatory system to replace the one that failed so badly. The bank regulators also have much to answer for, and it was the Federal Reserve that championed doing nothing about the shadow financial system that has now brought down the economy. But somehow the Fed has emerged as likely to take control of the regulatory apparatus when it is redone, while the S.E.C. has lost clout and reputation.

She showed herself a skilled infighter when the regulatory operations of the N.A.S.D. and the New York Stock Exchange were merged into Finra, a deal designed in part to reduce overlapping rules that raised costs for Wall Street. She emerged on top of the combined organization.

Chris Cox, the outgoing chairman, leaves behind a demoralized agency. Its regulation — or lack thereof — of Bear Stearns and Lehman Brothers became a subject of scorn. Now its failure to catch on to what Bernard Madoff was up to is condemned by Mr. Cox even before the investigation gets going, further damaging morale.

“I can recall nothing that rivals this in the history of the S.E.C. in terms of condemnation for how the staff had handled an investigation,” Jim Cox, a securities law professor and longtime S.E.C. watcher at Duke University, told Bloomberg News yesterday. (The two Coxes are not related.)

You may recall that relatively early in his tenure, Chris Cox did something similar after news organizations reacted with outrage to S.E.C. subpoenas of journalists. I assume he wants to send an image of an S.E.C. that is not afraid to admit its mistakes, but internally it came across as unprecedented for a chairman to rebuke the staff so publicly.

During his tenure, he moved to make it harder for the staff to file charges against companies, and the commission delayed settlements while commissioners negotiated to impose smaller penalties than the companies had agreed to pay( HE'S A DISASTER. PLEASE STOP CALLING HIM A LIBERTARIAN. THE BRAND WON'T RECOVER ).

She will have to decide whether to try to slow down the adoption of international accounting standards in this country, something Mr. Cox seems to want to make a fait accompli before he leaves.

With politicians and bankers pushing the S.E.C. to let banks fudge the numbers on their asset values by claiming they are worth more than any bank is willing to pay for them ( I KNOW SMART PEOPLE LIKE THIS, BUT IT CAN'T BE THE ONLY ACCOUNTING METHOD USED. I WOULDN"T MIND A DUAL SYSTEM ), she may have to decide whether to fight or cave.

If anyone can force a merger of the S.E.C. and the C.F.T.C., she can( RATIONALIZATION. I'VE SAID THAT IT IS ESSENTIAL FOR THESE REGULATIONS TO WORK IN PRACTICE. NO MORE SHOPPING FOR REGULATORS ). Only the futures industry lobbyists, who like the C.F.T.C.’s gentle non-regulation, and the House and Senate Agriculture Committees, who love getting Wall Street money, think it makes any sense to have one regulator for trading in stocks, and another one for trading in stock index futures ( I AGREE ). Everyone assumes the futures industry is too strong to allow such a merger to happen, especially with a president from Chicago. If she could persuade Mr. Obama to push strongly for such a merger, it would be a real sign that he is a serious reformer ( I AGREE ).

In picking Ms. Schapiro, Mr. Obama has chosen someone who knows all the issues and all the players and who is committed to effective and rational regulation."

The main function of the SEC, and it will accomplish this only if it does its job well, is to assure average citizens that the system isn't rigged in favor of the wealthy and powerful. That is, any more than it already is in its natural functioning. Otherwise, Jim Grant's call for the SEC's abolition, since it gives a false sense of security to investors, makes sense. Sometimes, poor regulation is worse than no regulation. The signs go from "Buyer Beware" to "Buyer Guaranteed".

I wish her luck, for all of our sakes.

Reports Of The Death Of Capitalism Are Greatly Exaggerated

A decent assessment:

"David Ruder, the former chairman of the Securities and Exchange Commission and now a professor emeritus at the Northwestern University School of Law, said he also thought that much stricter financial regulation was necessary, both in the United States and internationally. “The events, even as they’re unfolding today, are revealing the need for much closer cooperation among financial regulators,” he said.

But, in a sign of the opposition that Democrats will face as they try to strengthen regulation, Mr. Ruder said that he did not think regulatory reform would be easy to implement, even in the financial sector. Even after receiving massive government aid this year, banks may fight stronger government oversight next year, he said.

The banking and finance industries are major political donors and powerful lobbying forces in Washington. Lawmakers who voted for the bailout received substantially more in contributions over their careers from the finance, insurance and real estate industries than those who voted against it, according to the Center for Responsive Politics, a nonprofit group that tracks political contributions.

“I’m scared about the next year but I’m very optimistic we’ll come out of this in good shape,” he said. “We very well may come out of this horrible situation with a better version of American capitalism — it’ll be a little tamer; it’ll be a little more regulated.”

“But this country is built on an appetite for risk,” he added. “We don’t want to be France.”