Tuesday, September 1, 2009

Sheila, What Are You Smoking?

That was my reaction to Sheila Bair's op-ed piece in the New York Times today. Bair argues against creating a super-regulator to oversee all U.S. banks. Her reasoning unfortunately wouldn't pass muster in a high school Debating 101 course.

Let's deconstruct the thought processes of the Bair-ian mind.
The principal enablers of our current difficulties were institutions that took on enormous risk by exploiting regulatory gaps between banks and the nonbank shadow financial system, and by using unregulated over-the-counter derivative contracts to develop volatile and potentially dangerous products ... The creation of a single regulator for all federal- and state-chartered banks would not address these problems.

Okay, let's assume her "principal enablers" analysis is correct. Now tell me which model you'd have more faith in to regulate a banking system: a fractured hodgepodge of smallish regulatory bodies or one "super regulator" that probably has more awareness of systemic issues in the industry. Who is likely to be more vigorous in regulating OTC derivatives and exposing the dangers of the shadow banking system? The problems that really killed us in this financial crisis didn't come from the state or local level, they came from Wall Street. It was the massive intertwining of institutions and interests, and the securitizations, and the derivatives ... these problems didn't percolate up from the community banks. You need a Big Boy Regulator to get on top of this stuff.

Anyway, unfazed, Bair plows on. Not for her to do too much heavy-duty lifting in the thinking department. She charges that empowering a super-regulator "would endanger a thriving, 150-year-old banking system that has separate charters for federal and state banks." Okayyyyy ... and that is why?

Here's where Bair pulls off a neat little rhetorical trick. I don't know what the official name is, in debate lingo. Let's just call it "being misleading as hell" (though I think it's called "assuming the conclusion" or some such). She exalts local community banking (fair enough) and then suggests that these are the banks that would suffer under a super-regulator.
Concentrating power in a single regulator would inevitably benefit the largest banks and punish community ones. A single regulator’s resources and attention would be focused on the largest banks. This would generate more consolidation in the banking industry at a time when we need to reduce our reliance on large financial institutions and put an end to the idea that certain banks are too big to fail. We need to shift the balance back toward community banking, not toward a system that encourages even more consolidation.

Now, notice something interesting. Bair gives ABSOLUTELY NO REASONS FOR THESE STATEMENTS. "A single regulator's resources and attention would be focused on the largest banks." Um, why is that? Are you saying that big regulators naturally gravitate toward big entities? Is this an ironclad law, the "Third Law of Regulatory Attraction"? So it's then impossible to create a big regulator that, say, has a division called "Division in Charge of Local and Community Banking"? Or if you created that division, you're suggesting it would be ineffective? Yes? If so, on what grounds? Have you done a study? Or has someone else?

Bair, apparently believing that like God she doesn't need footnotes (or justification) for what she says, steams on and concludes that "a single-regulator system could also hurt the deposit-insurance system." Right! And that's because ... uh ... we're waiting, Sheila ... actually she doesn't give any reason there either, except to note that the all-powerful regulator might interfere with the FDIC's role in protecting depositors (now her agenda starts to grow a little more clear -- her column, sadly, just reflects a turf war among bureaucratic regulators; none of them is thinking out of the box, just trying to poke you in the eye if you get too close to dismantling their little fiefdoms). Of course the FDIC -- probably the best of class of the banking regulators, I'd argue, so I certainly like 'em -- could be rolled into the super-regulator, pretty much intact. What about that? But then of course, that leaves Ms. Bair not running an agency of her own (the FDIC), but rather a division of the super-regulator. And, you know, that doesn't look quite as nifty on your resume.

Bair's solution:
I have advocated the creation of a strong council of federal financial regulators.

So let me paint the picture for you, using the current Three Stooges Model of financial regulation we have now. Right now, Larry says he thought that Moe was regulating AIG. Moe says he thought Curly was regulating AIG. Now, in the new vision proposed by Bair, Curly can blame it all on another layer of bureaucrats, the "strong council of federal financial regulators."

Bair isn't done. Bair with me (couldn't resist):
One advantage of our multiple-regulator system is that it permits diverse viewpoints.

Okay, I know I'm going out on a limb here but: if you design a good super-regulator, that's robust and well-staffed, can't you have multiple viewpoints? That can happen within an agency, hard as it may be to believe.

Or, like Bair, you can just believe in having many regulatory agencies to preserve the diverse viewpoints. Following that line of thinking, I think we should break up the FDA into the Food Administration and the Drug Administration. Further, let's break the Food Administration into food groups, to gather in as many viewpoints as possible. For instance, let's have a Vegetable Administration and a Fruit Administration.

Then we can let the tomato growers decide whether to lobby for regulation by the Vegetable Administration or the Fruit Administration.

That's called "regulator shopping," by the way. And guess what? It's something that's encouraged when you have these multiple regulators that Bair seems so fond of. Countrywide, at the epicenter of the subprime loan crisis, did exactly that kind of regulator shopping as exposed in this excellent Washington Post article. "Regulator shopping" gives regulators perverse incentives to be more lenient on their supervised entities, as that way they can attract more regulatees and grow their budgets.

Sounds pretty bad. So, going back to her op-ed, what would Bair suggest we do about this clear problem with multiple regulators?

Hmm ... nothing in there ... imagine that.

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