by Sheila Bair
I credit Senator Chris Dodd with his effort to improve our financial regulatory structure to promote better quality, more independent decision making by the regulatory agencies. He was really the only member of Congress willing to tackle the issue head on. However, I believe strongly that vesting all power in a single agency would make it more prone to capture by the industry. Having a diversity of views and the ability of one agency to look over the shoulder of another is a good check against regulators becoming too close to the entities they regulate.
At the same time, the United States has gone too far in creating a plethora of regulators with responsibility for various pieces of the financial system. We do not have an efficient decision-making structure for them to collectively address systemwide problems. Each agency tends to focus on protecting its own turf, instead of stepping back and taking a broad view of regulatory measures that will protect the stability of the system as a whole.
My original proposal for a systemic risk council was to have it headed by a presidentially appointed individual with a fixed term whose sole responsibility would be to monitor and address risks in the financial system. The council head would have his or her own staff and be empowered to write rules for the financial system. The heads of each of the major regulatory agencies would serve on the council and would vote on the rules, but the rules would be approved by a simple majority. The individual agencies would retain responsibility for enforcing the rules against the institutions they regulated. They could also write their own rules for those institutions but only if they were tougher than the rules promulgated by the council. Allowing the individual agencies to write tougher rules would help change the captive mind-set of some of these agencies and also serve as a check on the council itself being too lax.
Unfortunately, the Financial Stability Oversight Council created by Dodd-Frank is chaired by the secretary of the Treasury, not an independent chairman. In addition, it has very little authority to write systemwide rules. Rather, those rules are now written as part of a painstaking negotiated process among rival agencies, producing rules that are hundreds of pages long, mind-numbingly complex, and sometimes riddled with special exceptions and exclusions, all too often to accommodate the interests of the individual agencies and the industries they regulate.
The ability of the council to function is also compromised by the fact that it is headed by an administration cabinet member.
As a member of the president’s cabinet, the Treasury secretary’s job is to serve the president and his political objectives. That sets up an inherent conflict with his FSOC responsibilities to promote a safe, stable financial system, even if it conflicts with administration policies or rubs powerful political constituencies the wrong way. We need an independent body with the ability and will to take away the punch bowl when the economy becomes overheated through excess leverage and risk taking. In the early and mid-2000s, it was obvious that investment banks were taking on too much leverage and mortgage-lending standards were out of control. It was obvious that the CDS market was getting out of hand. Yet in the face of massive industry resistance, the regulators did not act, and when Armageddon hit, each was able to say—with some justification—that it lacked the power to deal effectively with the problem because of its jurisdictional limits.
The council and its members need to have sole and complete ownership of system stability. They need to be led by an individual whose only job is to prevent another financial system meltdown. More than three years have passed since the crisis. Yet obviously needed reforms to raise capital requirements, reform the securitization market, and regulate the over-the-counter derivatives markets have yet to be completed and are bogged down in protracted interagency negotiations. The FSOC has played no role in cleaning up the robo-signing mess, which promises to be a huge drag on the financial system and our housing recovery. What’s more, the council has failed to take a forceful stand on probably the biggest long-term threat to financial system stability: the inability of Congress and the administration to deal with our structural budget deficit.
We need an FSOC that will look beyond the parochial interests of individual regulators. We need an FSOC that will be insulated from the reelection prospects of elected officials or the political fund-raising influence of financial institutions. We need an FSOC that will stand up to protect the interests of Main Street. This will happen only if it is independent and empowered to write the necessary rules.
Abolish the OCC
When I assumed the leadership of the FDIC, I did not have an ax to grind with the OCC. On the contrary, I had positive working relationships with John Dugan and his predecessors at the agency. Though I was deeply disappointed in its decision to preempt state consumer laws, I still had an overall favorable impression of the OCC as a regulator. In fact, I wrote an academic paper when I was at the University of Massachusetts suggesting the OCC as a possible model for federal insurance regulation.
However, after five years of dealing with the OCC as FDIC chairman, I question whether culturally or structurally it is capable of adequately supervising the nation’s largest banks. Let me hasten to say that there are many good people at the OCC, just as there were many good people at the Office of Thrift Supervision. Indeed, I found that John Bowman, who served on the FDIC board in his capacity as acting director of OTS, was much more supportive of regulatory initiatives than were John Dugan and John Walsh.
But let’s face it, the OCC has failed miserably in its mandate of ensuring the safety and soundness of the national banks it regulates. Citigroup and Wachovia, two of its largest charters, would have failed had it not been for government interventions and, in the case of Citigroup, massive amounts of taxpayer aid. Citigroup is a textbook example of how not to run a bank. The OCC allowed the bank we insured, Citibank N.A., to essentially become a dumping ground for high-risk assets. There was little, if any, effort by the OCC to protect the bank and make sure it was protected from risk taking by other Citigroup affiliates. The supervision of Wachovia was similarly weak. Wachovia had held a huge volume of toxic pick-a-pay loans on the troubled West Coast, it had gotten itself into trouble with complex auction-rate securities, and it had done a poor job of originating and managing a sizable commercial real estate portfolio.
Widespread problems with mortgage foreclosures must also rest on the OCC’s doorstep. The OCC has consistently thrown roadblocks in front of effective loan modification efforts. Beginning with its dissemination of grossly misleading redefault data in 2007 to its current efforts to gloss over widespread illegalities in foreclosure processes, it has consistently focused on protecting the interests of the large banks it regulates over the public interest. Years ago, the OCC should have been requiring the big national banks to hire the staff and resources necessary to restructure the avalanche of delinquent loans we could then see coming. Years ago, it should have made certain that the banks had the appropriate documentation and controls in place to ensure full compliance with state and local foreclosure requirements. Even now, it has failed to require that national banks spend the additional money necessary to service mortgage loans effectively. Our housing market cannot heal unless big-bank services are up to the task of dealing with the millions of delinquent loans still outstanding and the millions of properties now sitting vacant in communities throughout the country, hurting the home values of innocent neighbors. But so long as its regulator views its job as protecting the banks, not us, the situation will continue.
On other issues, the OCC has consistently argued for applying weaker standards to large national banks. Time and again, it pushed for lower capital requirements—during the stress tests, during the TARP repayment discussions, and finally during the Basel III discussions. It alone fought us on requiring servicing standards in the risk retention rules. But I think the most troubling of all my experiences over my five years in office was John Dugan’s statement to me in 2008 that it was unnecessary to lower Citi’s supervisory rating because the government was keeping it out
of trouble with massive financial support. In other words, the OCC did not need to do its job as a regulator because taxpayers were bailing out the bank. Main Street deserves better from a regulator.
The FDIC is not perfect, but it has repeatedly proven itself to be significantly more independent of the big banks than the OCC. One reason for this is that unlike the OCC, the FDIC faces huge financial losses if big banks get into trouble. In addition, it does not have to rely on fees from the nation’s biggest banks to fund itself, as does the OCC. The FDIC’s operations are supported through mandatory premiums charged to all insured banks.
Indeed, the best model for banking supervision would be to let the FDIC supervise all of the banks that it insures, while the Fed should supervise all bank holding companies and nonbank systemic institutions. My experience is that the Fed is a more independent regulator than the OCC because of its financial exposure as a lender of last resort and its ability to fund its operations through its lending and trading operations, without having to rely on big-bank fees. To be sure, the Fed had many failings as a supervisor prior to the crisis. However, many of those failings were the responsibility of the New York Federal Reserve Bank, not the Fed board. Since the crisis, the board has moved to exercise greater management control over the supervisory activities of its regional banks.
Moving all bank supervision to the FDIC and all holding company supervision to the Fed would also allow for better specialization between the bank regulators. The FDIC could focus on traditional commercial banking inside the insured banks, while the Fed could focus on financial activities outside traditional banking, such as securities, derivatives market making, and insurance. Each agency could have backup authority against each other (as the FDIC now has for all banks and holding companies) to guard against regulatory laxity.
My friend and former colleague on the FDIC board Tom Curry was confirmed by the Senate to head the OCC in the spring of 2012. I very much hope that Tom can change the regulatory culture of the OCC and refocus it on protecting the public interest, not the banks. However, he will be fighting an uphill battle, as the OCC’s decline as a regulator has been ongoing for many years. I wish him luck.
Merge the SEC and the CFTC
The securities and derivatives markets are heavily interrelated. Yet we continue to regulate them through separate and distinct regulatory agencies, the Securities and Exchange Commission for the securities markets and the Commodity Futures Trading Commission for most derivatives. The United States is the only developed nation that maintains separate regulators for those two markets. The agencies would be much stronger if they merged their respective staffs and pooled their areas of expertise. The combined agency would also have a broader perspective with a more diverse group of institutions to regulate, reducing the likelihood of regulatory capture.
Most experts on regulatory structure agree that the SEC and CFTC should be merged. So why hasn’t it happened? Primarily because agricultural users of the futures markets fear that their interests would be ignored if the CFTC were folded into the much larger SEC. Though I am sympathetic to their concern, I believe it could be adequately addressed by creating a special office within the merged agency, dedicated to making sure that the futures markets serve the needs of the nation’s farmers. Moreover, the Senate and House Agriculture Committees could retain oversight over the new agency, jointly with the Senate Banking Committee and House Financial Services Committee. That would help ensure that the new agency was attentive to agricultural users of the futures markets.
GIVE THE SEC AND CFTC INDEPENDENT FUNDING
Most financial regulatory agencies are “self-funded”—that is, they support their operations through fees that they assess on the industry. This gives them a great deal of freedom to plan their budgets and staff resources to carry out their mission independently of political interference. However, both the SEC and CFTC must rely on the congressional appropriations process for their funding. This means that each year they go hat in hand to the appropriations committees of the House and Senate to seek approval for money to continue to operate. (Both agencies collect registration and other fees as part of their work, but this money is turned over to the Treasury Department and then a portion of it is doled back to them as part of the appropriations process. The SEC in particular collects fees that are far in excess of the budget it is given by Congress.)
Regrettably, industry lobbyists have found that the best way to harass the SEC and CFTC and block efforts at financial reform is through convincing appropriations committees to restrict how these agencies can use their money. For instance, in the House, there have been attempts to prohibit the CFTC from using its funds to implement rules forcing more derivatives onto public trading facilities, and other measures. Such facilities would disclose pricing information to market participants before they decide whether to buy or sell a derivative (similar to the way you can obtain the current price of a stock before you decide whether you want to buy or sell it). This is an important reform that would help combat price manipulation in the derivatives market. The fact that the House Appropriations Committee would want to thwart it is even more troubling given the widening scandal over reports of major derivatives dealers manipulating a key interest rate index called the London Interbank Offer Rate (Libor) which impacts the price of hundreds of trillions of dollars worth of derivatives.
To be sure, this issue is about turf. The House and Senate Appropriations Committees do not want to give up their leverage over the SEC and CFTC. They argue that subjecting the SEC and CFTC to the appropriations process increases each agency’s accountability to the public. But the Senate Banking Committee and House Financial Services Committee have plenty of power to conduct oversight of the SEC and CFTC, and those committees have considerably greater expertise on financial matters than do the appropriations committees. I regret to say that I cannot think of one instance where the SEC or CFTC appropriations process was used to promote reforms to protect the public. On the other hand, the process is routinely used by industry lobbyists to create trouble for these two regulators. To be sure, both the SEC and CFTC have made mistakes, but their effectiveness will not be improved if their senior staff and chairmen have to spend time and resources on the Hill constantly battling industry lobbyists for enough money to operate. If we want vigorous supervision of securities and derivatives markets, both regulators need to have a process in place that gives them certainty that they will have adequate funds to discharge their responsibilities over the long term.
End the Revolving Door
When things go wrong, it’s usually the presidentially appointed heads of the agencies who take the heat. But in reality, the vigor with which rules are interpreted and enforced relies heavily on career staff. I have always been an advocate and supporter of career staff. While other agencies hired legions of advisers from the industry during the crisis, I pretty much relied on the FDIC’s career staff to carry out the FDIC’s vital mission.
If we want good people in government, we need to treat them with respect and let them know we value their work. If we signal through our hiring policies that we value industry professionals more than those who have chosen government as a career, we hurt morale and make it less likely that examiners and others will assert themselves against the industry when necessary. That is not to say that all career staff are perfect. I have seen many instances when career staff have been too deferential to industry wishes. At the FDIC, I did not want our examiners to be combative with the banks. But I did want them to exercise independent judgment and to understand that their job was to protect the public interest, not the banks.
It’s not just the examiners who can fall captive to industry viewpoints. The lawyers and economists who work at agencies can also be far too accommodating, if not gullible, when it comes to industry arguments. Lawyers in particular can become too focused on maintaining an agency’s jurisdiction, its “turf,” at the expense of good regulatory policy. For instance, for years, the SEC and CFTC
fought over which of them should regulate over-the-counter derivatives. With the agencies divided, the industry went to Congress and secured legislation banning both of them from regulating the industry.
I would like to see financial regulators, particularly examiners, develop a stronger esprit de corps. I would like to see financial regulation be viewed as a lifelong career choice—similar to the Foreign Service—rather than a revolving door to a better-paying job in the private sector. There should be a lifetime ban on regulators working for financial institutions they have regulated. We should impose higher educational and professional experience requirements for examiners and other staff when they enter government service, but also stronger training programs, ongoing educational support, and better pay. To be sure, industry experience can be helpful to a financial regulator, but that should be provided through government-paid industry tours of duty instead of an endless stream of staff moving back and forth between regulatory agencies and financial firms.
One area where a revolving door does make sense would be a requirement that federal regulatory staff accept rotations to other agencies. The financial regulators are not the only agencies where squabbling and infighting impede effective performance. We experienced tragic intelligence failures prior to the 9/11 terrorist attacks because of a lack of coordination and information sharing among law enforcement agencies. To promote better cooperation, the intelligence community has undertaken a mandatory rotation program for senior staff. This “joint duty” program requires all senior intelligence officials, as a condition of promotion, to undertake a duty rotation at another intelligence agency. Senators Joseph Lieberman, Susan Collins, and Daniel Akaka have introduced legislation to expand this program to include more agencies, and the Partnership for Public Service282 has recommended a similar program for the entire civil service. Just as it is doing for the intelligence community, requiring rotations of senior staff among the various financial regulators could help guard against regulatory capture and improve coordination and collaboration among the various financial agencies.