The new regulatory structure begins to emerge

By Felix Salmon
May 20, 2009

The WaPo all-star team of Zachary Goldfarb, Binyamin Appelbaum and David Cho broke the news this evening that Elizabeth Warren’s dream of a Financial Product Safety Commission is likely to become reality, thanks to the Obama administration. The WSJ’s Damian Paletta then did a fantastic job with his follow-up (although weirdly Warren’s name is nowhere to be seen):

Under the patchwork of regulation that presently exists, oversight of financial products is now split between a myriad of state and federal agencies, including the Fed, the Securities and Exchange Commission, the Federal Trade Commission, and others.

One possible scenario is that government officials consolidate some government agencies, such as the Office of Thrift Supervision, and strip some powers from the Federal Reserve and others to centralize the policing of financial products within a new body.

Anything which spells the end of the OTS (which, you’ll recall, was in charge of “regulating” AIG) is surely a good thing. And if the consumer-protection arms of the Fed and the SEC are bundled together into a new entity, that would surely reduce the chances of regulatory capture. As would this:

The creation of a financial product regulator would match a theme that Mr. Geithner has suggested is central to his vision of financial supervision. Instead of having regulators that look at specific companies, he has suggested having regulators that look horizontally at products and practices.

For example, he has called for the creation of a systemic risk regulator that would look at the concentration of risks in specific sectors, such as subprime lending. A financial product regulator could detect abusive practices in specific products, regardless whether a bank or small finance company originated the loan.

My feeling is that regulation by product — one entity regulating derivatives, another consumer-facing products (including insurance), and maybe a revamped SEC regulating securities — makes a great deal of sense. Then the Fed would sit atop those “horizontal” regulators, get data from them, and try to keep an eye out for systemic risks, with a particular emphasis on institutions which are too big to fail.

I’m reminded of the silliness that is the fact that Lending Club is regulated by the SEC — something extremely onerous for Lending Club, on the one hand, and something which is clearly outside the scope of what the SEC was designed to do, on the other. Instead, it, along with other peer-to-peer lenders, should be regulated by the new entity.

Is such a radical revamp politically possible? I think so, yes. Pointless regulators like the OCC and the NCUA might go by the wayside, but I doubt anybody will much mourn their passing, and most of their functions will be incorporated into the new horizontal regulators. The tougher fight will be with powerful state regulators, who probably have quite a lot of clout with the federal legislature. But it just doesn’t make sense to regulate financial products on a state-by-state basis, and it’s long past time that anachronistic practice came to a welcome end.


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