Financial Regulatory Forum

ANALYSIS-Deck chairs secure aboard USS Financial Regulation

By Reuters Staff
March 22, 2010

By Kevin Drawbaugh

WASHINGTON, March 21 (Reuters) – The big U.S. government agencies in charge of policing banks and markets, despite being excoriated over the severe 2008-2009 financial crisis, have successfully dodged a major structural shake-up.

While Congress may yet clamp down on the financial industry from Wall Street to Main Street, a top-to-bottom overhaul of the nation’s regulatory apparatus — which seemed like a certainty a year and a half ago — is not going to happen.

As political reality has tempered reform proposals, plans to reconfigure a patchwork bureaucracy stitched together over decades have faded from view, with just one agency closure still on the negotiating table.

Only the Office of Thrift Supervision — smallest and newest of the big seven agencies — is likely to be closed with regulatory reform bills in both the Senate and the House of Representatives targeting it for shutdown.

Otherwise, thousands of workers will stay in place at the Securities and Exchange Commission, the Federal Reserve, the Office of the Comptroller of the Currency and other agencies ensconced in stately, federal buildings across Washington.

Some of their work assignments may change — if Congress actually produces a bill this year and President Barack Obama signs it.

The Fed, for instance, would get some new responsibilities under legislation offered by Senate Banking Committee Chairman Christopher Dodd and under a sweeping House reform bill.

So might the Federal Deposit Insurance Corp, the Commodity Futures Trading Commission and the secretary of the Treasury, who could become the chairman of a new inter-agency council to monitor “systemic risk.”

But these changes, if ultimately approved, would signify a retreat from bold restructuring plans that were put forward by both Democrats and Republicans as far back as the turbulent final months of the Bush administration and right into Obama’s early days in office at the start of last year.

ENTRENCHED INTERESTS AT WORK

“Moving institutions around in Washington is like moving mountains across the Rockies — it’s more than hard to do,” said Karen Shaw Petrou, managing partner at Federal Financial Analytics, a firm that advises on regulatory policy.

“Entrenched interests at the regulators and the regulated create tremendous pressure to keep things as they are.”

That explains, partly, why restructuring is not happening on anything like the scale once envisioned at the height of the financial crisis, which tipped the U.S. economy into a deep recession and unleased a worldwide drive for reform.

For instance, there will be no merger of the SEC and the CFTC — agencies that regulate markets so closely linked that critics have said for decades that the two should be one.

A merger was recommended by former Treasury Secretary Henry Paulson in March 2008 and debated for months, but it was quietly shelved last year.

The main reason? Oversight of the agencies is split among committees of Congress whose members get campaign donations from bankers, brokers and others regulated by the agencies. Merging the SEC and CFTC would reduce that cash flow.

Another reason for structural inertia is that there is no clearly superior model versus today’s system, despite wide agreement that the dispersion of U.S. authority leaves gaps that often allow problems to fester.

Britain tried consolidating its bank and market oversight under one big umbrella — the Financial Services Authority — a decade ago. The FSA’s record has been spotty, at best.

Dodd floated an idea in November nearly as bold as the FSA concept, proposing a single super-cop for banks that would have centralized federal bank supervision jobs currently scattered across the Fed, the FDIC, the OCC and the OTS.

FIRA PLAN UNRAVELS

But Dodd’s plan unraveled in recent weeks amid lobbying against it by the Fed and opposition from Republicans closely allied with bank lobbyists keen to preserve the status quo.

Dodd unveiled a bill last week that dropped his super-cop proposal. In its place he proposed putting the Fed in charge of bank holding companies with more than $50 billion in assets. The central bank would also be charged with breaking up large financial firms threatening financial stability.

Also under the bill, the FDIC would supervise all state-chartered banks, and state bank holding companies with assets less than $50 billion. The OCC would police nationally chartered banks and thrifts, and holding companies of national banks with assets below $50 billion. The OTS would close.

The Dodd bill would close gaps in small and mid-sized bank supervision. But it would not put one agency clearly in charge of banks with more than $50 billion in assets, said Jaret Seiberg, an analyst at investment firm Concept Capital.

“Dodd’s bill gets part-way there. Where it falls down is for the mega-banks,” Seiberg said, noting he was looking at the issue from the investor’s viewpoint.

That reflects a decision by Dodd to tolerate some inefficiency in order to preserve the Fed’s involvement in bank supervision, a job the central bank claims gives it information crucial to managing monetary policy and the economy.

Dodd also backed away from his earlier support for a powerful new agency to handle systemic risk. Instead, he now supports an inter-agency council of regulators.

He also dropped from his bill Obama’s proposal to consolidate financial consumer protection duties now handled by a half dozen government units into an independent Consumer Financial Protection Agency.

OBAMA, FRANK BACK WATCHDOG AGENCY

The White House and House Financial Services Committee Chairman Barney Frank continue to support the idea of an independent watchdog for consumers. But to appease Republicans and banks, Dodd proposed putting the watchdog inside the Fed. His bill is likely to be the high water-mark for reform.

Congress’ inability to significantly restructure the system does not necessarily mean, of course, that lawmakers cannot do important things to improve financial oversight.

Both the House and Senate bills, for instance, would create a new protocol for dealing with distressed financial firms to prevent on-the-fly taxpayer bailouts like the ones the Bush administration launched for AIG and Citigroup.

Almost no one in Washington defends the current regulatory structure as optimal, but most agree that reform can only go so far, given the tremendous pressures against change from turf-protecting regulators and lobbyists.

“The fundamental problem in the run-up to the crisis wasn’t how many regulators there were — it’s that none of them did what they should have,” Shaw Petrou said.

“Thus, the key to reform isn’t moving the organization chart around a bit. Instead, it’s making whichever regulators end up in charge actually regulate.” (Reporting by Kevin Drawbaugh; Editing by Maureen Bavdek)

((kevin.drawbaugh@thomsonreuters.com, +1 202 898 8390, +1 202 488 3459 (fax)))

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