We’ve had TARP for banks, TARP for auto companies, and now, with the Obama Administration’s plan for financial regulatory reform, we have TARP for regulators. After AIG, Citigroup, Bank of America, and General Motors, the administration has decided that all the existing regulators are Too Big to Fail – except for the Office of Thrift Supervision, which must play the role of poor Lehman Brothers in this saga. (Actually, they are more like Merrill Lynch, since they are getting merged into the new National Bank Supervisor, so most of them will probably keep their jobs.)
There is actually a serious issue here, and one with no obvious solution. One question that has gotten a lot of ink, both before and after the unveiling of the plan yesterday, has been the identity of the systemic risk regulator: new agency? council of agencies? the Fed? What this really shows is that it’s easier for the media, the administration, and Congress to focus on the how the agency acronyms will be reshuffled, which is a bit like covering a sporting event, than on the underlying issues, like how to make those agencies more effective.
(Warning: I’m about to argue three sides of an issue.)
(1) So, for example, it’s a little ridiculous that the Federal Reserve is being given the role of systemic risk regulator, since the Fed (under Greenspan, but with no dissent from Bernanke) completely missed the housing bubble, the risks of a massive derivatives market, and the systemic implications of toxic mortgages that it was actually supposed to be regulating – and, in fact, contributed to the financial crisis by keeping interest rates low for the first half of this decade, and then helped aggravate it by letting Lehman fail. Yes, I know, most economists didn’t predict the crisis, either, but no one is nominating them for systemic risk regulator.
(2) But what’s the alternative? You could posit a new regulatory agency focused on systemic risk; let’s call it Bill. But you have no right to simply assert that Bill will do any better than the Fed. In fact, since Bill will start out with no building, no computers, and no staff, you could argue that the Fed, after being given an appropriate pep talk, would do better than Bill. It’s likely that many of the people working for Bill would be people who used to work for the Fed. Planet Money had a story a while back (I think it’s in this episode) about how when the Federal Home Loan Bank Board was abolished in the wake of the savings and loan crisis, its employees just kept on working and eventually the sign on the building was changed to Office of Thrift Supervision.
So given those alternatives, it’s easy for someone as smart as Larry Summers to argue that the Fed is a better choice than a new agency, or a committee, as he did on All Things Considered today. Basically he is positing an ideal Fed – one with the technical skills it has today (according to Summers) but not the huge blind spots it had in the past. I can posit an ideal Bill, but it won’t be any better than his ideal Fed.
(3) The real issue behind this reshuffling of agencies and responsibilities is how you can get better regulators – people with the skills, motivation, and stomach to stand up to both banks and politicians who are screaming at them to get out of the way of progress and prosperity. And here I don’t think the administration’s plan gives us anything.
What could it have done? Here’s one idea: it could have spun the regulatory agencies off into semi-independent bodies, so their heads aren’t replaceable at will by political figures (as is currently true of the Fed); established a long prohibition (5 years?) on making any money from the financial sector after leaving the agency; and then doubled the salaries of every single regulator. (I know there are some transition issues you would have to deal with, like getting rid of a lot of the people who were asleep at the wheel.)
That would be a step toward increasing the status of regulators and reducing the threat of regulatory capture. I’m sure there are problems with these proposals, but at least they address the real problem.
Tellingly, the administration’s executive summary of its proposals highlights “compensation practices” as a key cause of the crisis, but then fails to say anything about addressing those practices. The long-form version says more, but what it says — “Federal regulators should issue standards and guidelines to better align executive compensation practices of financial firms with long-term shareholder value” — is a description of what should happen, rather than a plan to make it happen. . . .
In short, Mr. Obama has a clear vision of what went wrong, but aside from regulating shadow banking — no small thing, to be sure — his plan basically punts on the question of how to keep it from happening all over again, pushing the hard decisions off to future regulators.
The question with this package is not if it’s well-suited to a world where regulators want to regulate. It’s if it’s well-suited to a world in which they don’t. A world in which growth is quick and greed looks good. A world in which Wall Street seems to be helping Main Street buy, if not houses, then a surprising number of wind turbines. One of the lessons of the past few years is that regulation has to be impartial and disinterested because regulators, and even Fed chairman, get swept up in the cultural manias behind asset bubbles as surely as traders do.