Today, Treasury Secretary Henry Paulson is set to present some comments about the Treasury’s Blueprint for Financial Regulatory Reform, released on Saturday. (A summary of the proposal is here.)
The summary of the proposal report provides: “In this report, Treasury presents a series of “short-term” and “intermediate-term” recommendations that could immediately improve and reform the U.S. regulatory structure. The short-term recommendations focus on taking action now to improve regulatory coordination and oversight in the wake of recent events in the credit and mortgage markets. The intermediate recommendations focus on eliminating some of the duplication of the U.S. regulatory system, but more importantly try to modernize the regulatory structure applicable to certain sectors in the financial services industry (banking, insurance, securities, and futures) within the current framework.”
I have a few comments on the proposals:
1. The report contemplates consolidation of market regulators for the securities markets and the commodities markets. This is a difficult issue. Intuitively, I like the notion of consolidating regulation, as the regulatory authority dealing with commodities (the CFTC) and regulators of the general securities markets (SEC) both regulate the markets for securities. That said, commodities regulation is (a) incrementally more sophisticated than the regulation of the generic securities markets due to the increased complexity in products, their evolution, and their likely economic/market impact and (b) different in sort than the regulation of plain vanilla securities. Moreover, my impression – based on my experience working at the SEC and my experience as a corporate/securities/business scholar – is that the CFTC does a bit of a better job than the SEC in avoiding political pressure. (Think about it – while we can easily recall a series of SEC Chairmen resigning under pressure, can we easily recall a series of CFTC Chairmen resigning under pressure?) Is it sensible to combine agencies and lose that market niche insulation?
2. The motivation for Treasury’s proposals strikes me as questionable. The report summary says: “Market conditions today provide a pertinent backdrop for this report’s release, reinforcing the direct relationship between strong consumer protection and market stability on the one hand and capital markets competitiveness on the other and highlighting the need for examining the U.S. regulatory structure.” Indeed, the argument was made in connection with last spring’s Paulson report that the US capital markets are becoming less competitive, in part due to mis-regulation (and overregulation).
But the argument that the US capital markets are becoming less competitive continues to be the subject of robust academic debate. (For example, Howell Jackson, Jack Coffe, Kate Litvak, and Don Langevoort, all very credible scholars, expressed differing views on the issue at the AALS annual meeting this past year.) I, for one, do not believe that the US capital markets are becoming less competitive. Instead, I believe that the overseas markets are becoming *more* competitive. That is not a bad thing, nor is it reason to overhaul US market regulation. In reality, maybe the increasing competitiveness of overseas capital markets counsels in favor of our holding the status quo, to see how things shake out with the fundamentals that make the overseas markets increasingly competitive in the short term.
To that end, the report summary says “[g]lobalization of the capital markets is a significant development. Foreign economies are maturing into market-based economies, contributing to global economic growth and stability and providing a deep and liquid source of capital outside the United States. Unlike the United States, these markets often benefit from recently created or newly developing regulatory structures, more adaptive to the complexity and increasing pace of innovation.” Until we know how these more newly developed regulatory structures fare in the long term, is seems unwise to jump to action to keep up with them. Moreover, the summary of Saturday’s report indicates that its authors looked closely at the UK, Australia, and Netherlands financial markets regulatory regimes in designing the proposals in the report. Basing reform of the US capital markets on regulation in the UK, Australia, and the Netherlands, however, does not strike me as sound. If we are entertaining notions of wholesale reform, why not instead pin down what the conceptual optimal model would look like, as opposed to mining for inspiration from other regulators? That said, the report purports to so do, to a degree, as discussed below in point three.
3. The report touts a new “objectives based regulatory approach.” This approach, however, while radically different from the current US capital markets regulatory structure in terms of how it is implemented, is nothing new in terms of goals. (Indeed, the summary says the new structure is motivated in part by “the convergence of financial services providers and financial products has increased over the past decade. Financial intermediaries and trading platforms are converging. Financial products may have insurance, banking, securities, and futures components.” But wasn’t this dealt with in the Gramm- Leach-Bliley Act? Why now do we need to revisit what appears to have been sensible reform less than a decade ago?)
The report summary says “[l]argely incompatible with these market developments is the current system of functional regulation, which maintains separate regulatory agencies across segregated functional lines of financial services, such as banking, insurance, securities, and futures,” and the report instead argues for an objectives based regulatory scheme, based on the objectives of “[m]arket stability regulation…, [p] rudential financial regulation…, and [b]usiness conduct regulation.” But our current functional regulatory scheme operates with a focus on these exact objectives. A consolidation of power into one regulatory authority for each objective seems to do nothing other than allow for (a) tunnel vision by a given objective’s regulator and (b) decreased input in terms of how to regulate to the goal of meeting these objectives. With respect to point “b,” I believe that it is useful to have the leaders at the SEC, the CFTC, and the Federal Reserve all making calls to each other, giving input to the President and Congress, and agitating for ways to secure better regulation. Yes, there is tension and a bit of repetitive regulation, but it seems to me that that is healthy when dealing with a matter as important as the United States capital markets.
4. I have not worked through exactly how Saturday’s report proposes, if at all, to restructure the actual Board of Governors of the Federal Reserve System. I will note, however, that I am generally leery of restructuring the Federal Reserve, both in terms of authority and operation. Part of what makes the Federal Rserve work is the fact that the Governors serve for 14 year terms, allowing for insulation from political pressure (to a degree) and a link between immediate decision-making and longer-term implications. (Contrariwise, the SEC Commissioners are usually long gone before the fall-out from their decisions becomes manifest.) The Federal Reserve System has worked well for almost 100 years. Does it really make sense to tamper with it?
5. To paraphrase, “regulate in haste and repent in leisure.” I am never thrilled to see a massive proposal for overhaul and reform on the heels some major business or economic event. Did the aftermath of the Sarbanes-Oxley Act (which is an act that I support, by the way) teach us nothing?
David Zaring and Gordon Smith have some interesting comments over on the ‘Glom, as does Larry Ribstein on his blog.
I agree that regulating in the midst of a financial crisis is not optimal but unfortunately Congress almost never acts until there is such a crisis.
The Gramm-Leach-Bliley Act allowed financial services firms to offer a wide array of products but did not significantly alter the way financial services firms and products were regulated. As a result, a company like AIG or Citigroup must deal with over 115 state and federal regulators if they want to operate in all 50 states.
While the functional regulators do regulate some risks, they do not necessarily consider all the risks posed by a firm or product. For example, the SEC does not really engage in prudential regulation while the banking regulators are so concerned about prudential risks that they frequently fail to adequately address market conduct risks.
Almost 50 nations use either a single regulator or a semi-integrated regulator (including major competitors like the UK, Japan, and Germany) and some have been doing so for over twenty years. I don’t believe that we need to continue to wait and see how they work out before acting.
Consolidating our regulators poses both benefits and problems, which I have outlined in some detail in my article on creating a single US Financial Services Authority available at SSRN: http://ssrn.com/abstract=757010
On the whole, I think that the benefits will out weigh the costs.