Regulatory consolidation

By Felix Salmon
August 25, 2009
Kevin Drum and Ryan Avent bring up the question of optimal regulatory structure, and I agree with both of them.

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Kevin Drum and Ryan Avent bring up the question of optimal regulatory structure, and I agree with both of them.

Kevin is right that the Federal Reserve — which is owned by big banks and whose regulatory function exists to keep them strong — is not naturally inclined to protect consumers: after all, banks which treat consumers badly are often that much more profitable. The Fed, writes Kevin, is

institutionally and culturally oriented toward the financial community and macroeconomic management. Consumer regulation will never be taken seriously there no matter how many laws we write.

Well, “never” is a long time. But I think he’s right, practically speaking: if a Consumer Financial Protection Agency were to be created under the auspices of the Fed, then its officers would be taken less seriously than the prudential regulators overseeing systemic risk.

That said, however, a lot of the time all of those officers would be pulling in the same direction. Subprime mortgages are only the most obvious example: what’s bad for consumers can be systemically dangerous, too. And there would be advantages, as well as disadvantages, to a CFPA being part of the Fed: once senior Fed officials were convinced that the CFPA had legitimate concerns about a certain institution, there would be no question that the bank in question would reform its activities sharpish.

Which brings us to Avent, who has “a tough time seeing how a more fractious regulatory environment is a better one”. There are very good reasons why a single regulator is much better than an alphabet soup, where senior management at the various different agencies spend more time fighting with each other for power and influence than they do actually regulating. Ryan misunderstands my earlier blog entry: I don’t for a minute think that regulatory authority should be distributed. To the contrary, I think that it should be consolidated: the CFTC should merge with the SEC, the combined agency should become part of the Fed, and eventually, as the Tories are suggesting in the UK, the central bank should regulate everything.

Is such a thing realistic, or would the resulting behemoth be too big to manage, a bit like Citigroup? I think the answer would be to make the different arms of the super-regulator largely autonomous, but to encourage employees to move from one part of the institution to another quite regularly. Infighting within an institution is generally easier to manage and minimize than fighting between institutions.


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Yes, Felix consolidation is so very convenient. That way the big money-center banks only have to force one of their lapdogs into the top spot to control the whole regulatory edifice. Once done, they can be assured of no more threats from that corner. And Felix will be invited to all the best cocktail parties as he reports on the next massive financial meltdown, currently scheduled for 2013.

Posted by Grrrr... | Report as abusive

The central fed — the board of governors and its employees in Washington — is under less control of the big banks than the regional banks are, and I assume rules would be promulgated from Washington, though one might worry about the execution by regional reserve banks. Reform of the governance structure of the regional banks would make sense, though I’m sure it would be difficult, and even broaching it would probably open something of a can of worms.

Grrr: You optimist. I’m thinking 2011 for the next meltdown, or maybe even 2010…

Posted by Felix Salmon | Report as abusive

For those of you who are not financially literate, you should be informed that the Truth in Lending Act (TILA) of 1968 uses a mathematically-untrue, simple-interest method to calculate the Nominal Annual Percentage Rate (NAPR). That is calculated by multiplying the interest rate for a period by the number of periods in a year. The mathematically-true, compounded, Effective APR (EAPR)is calculated by compounding the interest rate for a period to the power of the number of periods in a year. Back in 1968, compounding was not available on small-business calculators. The banks opposed using the EAPR and the authors of the bill (Sen. William Proxmire and Rep. Leonor K Sullivan) acquiesced. Back then Ms. Sullivan contemplated making 18% the maximum NAPR that could be charged, but dropped it.
An example of the difference that occurs, with high periodic rates and short periods, is a loan described in the February issue of Consumer Reports, where a school principal took-out a $400 loan to be repaid with $120 in interest in 16 days. The NAPR, in accordance with Regulation Z of the TILA, is the rate for a period times the number of periods in a year (120/400)*(365/16) = 684%. The mathematically-true APR is the compounded, EFFECTIVE (a named steeped in history) APR (EAPR), the rate for a period compounded (“^”) for the number of payment periods in a year (((1+(120/400))^(365/16))-1) = 39,650%. On the Nominal APR, TILA states the tolerance of accuracy of this “closed-end’ (a stated due date) loan as 1/8th% (0.125%). In this example the Effective APR is 311,728 of those 1/8th%s from the Nominal APR (39,650%-684%)/0.125% … astronomically wrong. In 1968, when interest rates were low (5%) and periods longer (monthly) the Nominal and Effective APRs were very close. In this case the EAPR is 58 times greater than the NAPR (39,650%/684%).
Now, you may find the above unbelievable, so please check with a teacher of graduate finance, especially a PhD who does not have any obligations to any financial organization or government entity. A $4.95 LeWorld hand-held calculator at Wal-Mart has a compounding function. The Truth in Savings ACT uses the EAPR and calls it the Annual Percentage Yield (APY). To change TILA to the truth, the words “multiplied by” should be changes to “compounded for”.

Posted by A F "Bob" Blair Jr | Report as abusive

I disagree. Simply put, the purpose of the consumer protection piece is to fight the banks. It’s director should be independent of the Fed. I would love some external regulatory infighting, splashed in the newspapers. I would love an ambitious consumer protection head, making trouble and knowing only the President could fire him or her.

We need more populism in this country, and fewer “internal” decisions.

Posted by Dollared | Report as abusive

Dollared, Is there something you disagree with that I wrote? I can’t imagine what. You would do well to read the Truth in Lending Act at: es/6500-1400.html . You will read at 226.1(b) that the purpose of the act is stated: “Purpose. The purpose of this regulation is to promote the informed use of credit by requiring disclosures about its terms and costs.” To validate your pugilistic-loving fervor, you might want to read the whole act including the Appendices. Google, and I think that you will find that that the President has appointed Elizabeth Warren (Harvard Professor and winner of consumer awards) Czar of over-sighting the financial governing.

Posted by A F "Bob" Blair Jr | Report as abusive