But the most unusual twist is a new financial reform proposal in the works from the GOP. According to Reuters, which cites draft documents of the idea, congressional Republicans are close to coming up with a proposal to rein in the Federal Reserve and expand the bankruptcy code.

Here’s the best part: The Republicans apparently want to create an advisory board of regulators – which would have absolutely no enforcement or oversight powers. Now that’s putting teeth into reform! Clearly, the Republicans are alone in finding that the financial crisis must have been caused by regulators with too much authority on their hands.

The Republican draft package opposes giving systemic risk authority to the Federal Reserve, an idea that sources have said the administration favors, but many lawmakers distrust.

Instead, the Republicans call for creating a board of regulators and outside experts, chaired by the Treasury secretary, to study systemic risk and report quarterly. The board would have no enforcement or supervisory powers.

Another high priority of the Obama administration is empowering an agency, probably the Federal Deposit Insurance Corp (FDIC), to seize and unwind troubled non-bank financial institutions. The idea is to avoid on-the-fly bailouts in the future like that of American International Group.

But Republicans, in a sharp repudiation of the bailout policies begun under former President George W. Bush, say in the draft document that they oppose such “resolution authority” and, instead, favor adding a new chapter to bankruptcy law.

I’m sure you feel much better about the stability of the financial system now. This reminds me of when the Republicans unveiled their alternative budget — with no details.

Maybe this new proposal for financial reform will come with charts as well.

For what it’s worth, I’d say that having a single bank regulator is long overdue.  The current structure not only doesn’t make sense, but allows banks to shop around for the most lenient regulator they can find, prompting a race to the regulatory bottom.  It’s also a problem for big banks, which end up under the regulatory authority of multiple agencies.

According to The Post, the new regulator would replace the patchwork of agencies that now regulate financial institutions.

The agency would be a key element in the administration’s sweeping overhaul of financial regulation, which officials hope to unveil in coming weeks, including the creation of a new authority to police risks to the financial system as well as a new agency to protect consumers, according to three people familiar with the matter. Most of the proposals would require legislation.

Drum finds himself slightly leery of the systemic risk regulator, saying he’s not sure such an authority would have done anything to head off the current crisis. He’d also like to see more specifics on the guiding principles behind regulatory changes, not just new rules. I’ve got other concerns.

The fact that most of the proposals require legislation should be cause for concern, given the way Congress caved in to the banks on mortgage cramdown legislation that should have been a slam dunk. Do not underestimate the financial industry’s lobbying clout and the survival instincts of agencies likely to be targeted for elimination, such as the Office of Thrift Supervision.

And speaking of the OTS … this little nugget mostly got overlooked last week, and it’s worth a mention. The inspector general for the Treasury Department found evidence of improper backdating at six thrifts, including failed subprime lender IndyMac. From Reuters:

High-level bank regulators were aware that thrifts were inappropriately backdating capital contributions, allowing the institutions to appear healthier, and in one case directed a thrift to engage in the practice, according to a government watchdog report released Thursday.

The inspector general’s report called the practice “alarming.” I’d go beyond that and question whether it’s criminal — isn’t this sort of thing blatant accounting fraud?

So what does this all have to do with regulatory reform? Plenty. As we’ve noted, insurance companies recently partnered with the OTS to buy troubled thrifts, which allowed them to qualify for TARP funds. Here’s how we’ve described this little arrangement:

Banking analyst Bert Ely told TWI that the insurers actually were teaming up with the Office of Thrift Supervision, which found them troubled thrifts to buy.  That way, insurers could get a chance at TARP money – and avoid stricter federal oversight. Buying thrifts instead of banks would allow the insurers to be regulated by the Office of Thrift Supervision, which is well-known for its lax oversight.

Ely also told us he once thought OTS would go down in flames after several failures of the institutions the agency was supposed to be overseeing, like IndyMac and Washington Mutual. But with the insurers involved, he said, the picture has changed. The OTS now has powerful friends with a vested interest in seeing it survive, and who will be likely to lobby for its survival.

That’s one reason why I’m not counting on the creation of a single regulator or any other good idea to become a reality. Already, according to American Banker, former OTS director John Reich, a deregulatory zealot if there ever was one, is coming out swinging to defend his former agency’s practices. I guess it’s the financial industry’s version of the debate over the Bush administration’s policies on torture.

Except the financial industry’s people have very deep pockets, and Congress often ends up on their side.

The proposal, still being drafted, is likely to give the Federal Reserve more authority to supervise financial firms deemed too big to fail. The Fed may inherit some SEC functions, with others going to other agencies, the people said. On the table: giving oversight of mutual funds to a bank regulator or a new agency to police consumer-finance products, two people said.

The 75-year-old SEC, chartered to oversee Wall Street and safeguard investors, has seen its reputation tarnished as some lawmakers blamed it for missing the incipient financial crisis and failing to detect Bernard Madoff’s $65 billion Ponzi scheme. Any move to rein in the agency is likely to provoke a battle in Congress, which would need to approve the changes, and draw the ire of union pension funds and other advocates for shareholders.

In addition to the SEC proposal, the Obama administration also is considering creating a regulatory commission with broad authority over consumer financial products such as mortgages and credit cards, according to The Washington Post.

That idea mirrors a proposal of top TARP watchdog Elizabeth Warren, who has long argued for the creation of a Financial Products Safety Commission. The purpose of such a commission would be to provide safeguards so consumers would understand exactly what they were getting into when they signed up for mortgages and credit cards.

As Bloomberg noted, financial regulatory overhaul is likely to spur a tough turf battle, as agencies like the SEC or the Office of Thrift Supervision lose some powers or mergeinto other agencies.  And as TWI has pointed out, Warren has become a lightning rod for right-wing critics, who see her as too biased on behalf of consumers.

The fact that the Obama administration is seriously considering her pet project provides a glimpse of which way those in power already are leaning. Score one for Warren, in the long financial regulatory turf war to come.

But it wasn’t always this way, as Thomas Frank reminds us today in a Wall Street Journal opinion piece. Frank reviews the history of the Pecora Commission, a congressional panel that investigated bank misdeeds during the Great Depression. Its findings were used to create new laws to curb financial industry abuses that kept banks in check for decades, until many of those regulations went out the door, beginning in the 1990s.

In the course of its investigation, the Senate Banking Committee, which brought on as its counsel a former New York assistant district attorney named Ferdinand Pecora, heard testimony from the lords of finance that cemented public suspicion of Wall Street. Along the way, the investigations formed the rationale for the Glass-Steagall Act, the Securities Exchange Act, and other financial regulations of the Roosevelt era.

Frank, author of “What’s the Matter with Kansas?” writes that the idea of a new Pecora Commission is catching on, at least on the left. But it’s not likely it will become a reality. This time around, Congress would have to investigate itself — and its role in paving the way for the deregulatory zeal that is cited as the source of many of the financial system’s problems today.

The crisis today is not solely one of bank misbehavior. This is also about the failure of the regulators — the Wall Street policemen who dozed peacefully as the crime of the century went off beneath the window.

We have all heard the official explanation for this failure, that “the structure of our regulatory system is unnecessarily complex and fragmented,” in the soothing words of Treasury Secretary Tim Geithner. But no proper Pecora would be satisfied with such piffle. The system was not only complex, it was compromised and corrupted and thoroughly rotten even in the spots where its mandate was simple.

After all, we have for decades been on a national crusade to slash red tape and stifle regulators. Over the years, federal agencies have been defunded, their workers have grown dispirited, their managers, drawn in many cases from antiregulatory organizations, have seemed to care far more about industry than the public.

Frank also points out the difficulties of investigating how the free market philosophy of the Bush administration went too far:

Consider in this connection the 2003 photograph, rapidly becoming an icon of the Bush years, in which James Gilleran, then the director of the Office of Thrift Supervision (it regulates savings and loan associations) can be seen in the company of several jolly bank industry lobbyists, holding a chainsaw to a pile of rule books. The picture not only tells us more about our current fix than would a thousand pages about overlapping jurisdictions; it also reminds us why we may never solve the problem of regulatory failure. To do so, we would have to examine the apparent subversion of the regulatory system by the last administration. And that topic is supposedly off limits, since going there would open the door to endless partisan feuding.

But as Frank notes, Republicans alone aren’t to blame. It was former President Bill Clinton and his Treasury Secretary Larry Summers who pushed for the measure that overturned Glass-Steagall’s separation of investment from commercial banking.

Given all this, what are the chances that Republicans and Democrats will join hands to probe what went wrong during the financial crisis, and then work together to craft purposeful regulations to make sure another crisis never occurs? Pretty much nonexistent.

Based on the cramdown experience, banks are rolling over Congress already. It’s as if the Pecora Commission is already just a distant memory. The lack of action by Congress to figure out what really went wrong, and to take steps to fix it, will be the enduring scandal of this financial crisis.

Here’s the part that particularly interested me:

A number of life insurers, including Hartford Financial Services Group Inc., Genworth Financial Inc. and Lincoln National Corp., struck deals last fall to buy regulated savings and loans so they could call themselves banks and qualify for government funds. Hartford and Lincoln have applied for TARP funds. Genworth said it has applied with the Office of Thrift Supervision to approve its thrift purchase as a step toward gaining access to the federal funds.

In January, TWI reported on this development — but it goes beyond what The Journal reports.

Banking analyst Bert Ely told TWI that the insurers actually were teaming up with the Office of Thrift Supervision, which found them troubled thrifts to buy.  That way, insurers could get a chance at TARP money – and avoid stricter federal oversight. Buying thrifts instead of banks would allow the insurers to be regulated by the Office of Thrift Supervision, which is well-known for its lax oversight.  Thrifts, or savings and loans, operate slightly differently from banks (which traditionally focus on commercial loans, in addition to deposits, and are regulated by the Federal Reserve) because thrifts concentrate on mortgage and real estate lending — though the distinction has blurred in recent years. If insurance companies had purchased banks instead, they would be subject to stricter oversight by the Federal Reserve.

Now that Treasury Secretary Timothy Geithner has proposed a sweeping expansion of federal oversight of the financial regulatory system, the insurers’ OTS strategy  might not work, anyway. But until any new system is in place, the insurers have found and exploited a regulatory loophole while no one noticed — and the move gives the OTS  powerful allies as it fights to survive any new regulatory reorganization.

Here’s how Ely summed up the situation, from TWI’s story in January:

The notion of insurance companies buying thrifts to get government money and avoid stricter federal regulations at the same time should be troubling, Ely said. If the companies bought banks instead, they could still get TARP money – but as bank holding companies they would be subject to tougher oversight, including more stringent requirements for reserves set aside to cover possible losses, among other things. “I can’t help but conclude that plays a role in why these companies are going out and buying crappy thrifts,” Ely said. “This ought to be generating some questions and concerns.”

Apparently, it’s not generating enough questions to keep all the deals from going through. It will be well worth keeping  an eye on what happens at OTS now. If it retains its authority as the Obama administration restructures the financial regulatory system, we’ll all know which powerful friends the office will have to thank for that.

Just a few months ago, after the failures of Washington Mutual and IndyMac Bancorp shook the financial world, industry consultant Bert Ely would have bet it was time to shut down the Office of Thrift Supervision. The government regulator doesn’t exactly have a track record to brag about: It’s at the forefront of the most severe housing market meltdown in a generation. The government last year seized three of the largest institutions it regulates. It oversaw Washington Mutual, by far the largest bank failure in American history. Officials on both sides of the political aisle, from Treasury Secretary Henry Paulson to regulatory experts, want to see it disbanded.

Illustration by: Matt Mahurin

But these days, Ely isn’t so sure. Although yet another scandal hit the OTS recently – a senior regulator was demoted after allegedly approving backdated IndyMac documents that made the bank appear more viable than it actually was, two months before it failed – the OTS may have discovered a way to survive. The agency, the primary regulator for savings and loans that specialize in mortgage lending, is finding new customers – and supporters – in the insurance industry.

At least three large insurance companies are waiting for approval to buy troubled thrifts and become eligible for bailout money from the government’s $700 billion Troubled Assets Relief Program, both the firms and the industry’s trade group said. The intent of TARP was not to help insurers buy ailing thrifts, and the insurers themselves are not in financial peril. But the companies applied in November, on the deadline for signing up for TARP money, to become savings and loan holding companies. The move would allow them to buy thrifts and qualify for government help – and, as an added bonus, be regulated by the OTS, instead of subject to stricter oversight by the Federal Reserve, Ely said. American Banker reported that four companies reached out to OTS to find troubled thrifts for them, and OTS cooperated.

The deals are still pending, OTS spokesman William Ruberry said. Until sales of the thrifts are final, the Treasury Department can’t make a decision on awarding the funds. One firm, Aegon NV, has since has withdrawn its application. But Jack Dolan, spokesman for the American Council of Life Insurers, an industry trade group, said additional insurers also have sought to buy thrifts and get TARP money, although his group doesn’t track the exact number. “The list may be longer” than just the three companies, he said.

Ely said the fact that insurers are trying to forge a partnership with the OTS to get the bailout funds means the troubled agency has gained some powerful political friends, who might not just sit back and watch if a new Obama administration tries to downsize or eliminate the OTS. Paulson last April called for the agency to be folded into the Office of Comptroller of the Currency, the nation’s top banking regulator. President-elect Barack Obama pledged recently to substantially overhaul the financial regulatory system.

“I was ready to say the OTS was history, but now I’ve changed my handicapping system,” said Ely, a leading banking industry observer. “It has gained a new set of allies – the insurance industry.”

The notion of insurance companies buying thrifts to get government money and avoid stricter federal regulations at the same time should be troubling, Ely said. If the companies bought banks instead, they could still get TARP money – but as bank holding companies they would be subject to tougher oversight, including more stringent requirements for reserves set aside to cover possible losses, among other things. “I can’t help but conclude that plays a role in why these companies are going out and buying crappy thrifts,” Ely said. “This ought to be generating some questions and concerns.”

Arthur Wilmarth, a George Washington University law professor who specializes in banking regulation, said he also believes insurers are drawn by OTS’ reputation as a “loosey-goosey” regulator, likely to go easy on its customers. “It’s not like there aren’t any sick banks to buy,” Wilmarth said. “There are 171 or so banks on the FDIC problem list. They must think that, at least for a time, they’ll be under an easier regime.”

The three firms that filed on the TARP deadline are the Hartford Financial Services Group, Lincoln National Corp., and Genworth Financial Inc. Representatives for Hartford and Genworth declined comment. Lincoln National did not respond to a request for comment. Aegon said in a statement it anticipated a stronger 2009 and decided not to seek TARP money. Private equity investors seeking to buy IndyMac also want to operate as a savings and loan holding company and be overseen by the OTS, the agency said.

Dolan, however, said he didn’t believe the insurers chose to buy thrifts just to come under the OTS umbrella. “Thrifts and banks do function somewhat differently,” he said. “The reason some insurers may be seeking thrift charters is that they fit the business model better than a bank charter.”
But regulatory experts say they see little other reason why insurers would choose specifically to buy thrifts, besides the OTS’ role in regulating them. As bank failures mount, they say, the agency’s actions during the housing boom, and its zeal for deregulation during the past eight years, are under closer scrutiny.

Patricia McCoy, a University of Connecticut law professor who specializes in subprime securitization and banking regulation, said inadequate OTS oversight in the past few years has included firms from failed subprime lender Countrywide Financial Corp. to insurance giant AIG and its involvement in credit default swaps. (AIG bought a savings and loan nine years ago.) The failures show how entrenched the agency’s problems have become, she said.

The OTS has been headed by “two very ideologically tilted directors who believe in deregulation with a passion,” McCoy said: James Gilleran, who began his term in 2001, and current director John Riech, who took office in 2005.

In 2003, Gilleran posed with the three other federal banking agency officials for a photo to illustrate the Bush Administration’s commitment to cutting red tape. Gilleran wielded a chainsaw instead of garden shears.

A review of the agency’s history of enforcement actions prior to bank failures or takeovers show that its actions were either late, or inadequate, McCoy said. Thrifts would be cited for compliance problems with flood insurance certificates, for example, rather than mortgage quality. The IndyMac backdating controversy is the latest debacle that should put an end to the question of the agency’s ability to function in its current form, she believes.

“The OTS is the worst federal regulator on the block,” she said. “It has a culture of being so permissive and cozy with the thrifts it regulates, that you can’t really break it without major reform. What we’re seeing is not only an attitude from the top but a pervasive way of doing business that has permeated even the front line examiners at OTS.”

Washington Mutual, which was seized by federal regulators in September, serves an example, she and others said.

The OTS had examiners on site at WaMu, “all the time, 24-7, and 365 days a year,” said Wilmarth, of GWU. Yet regulators somehow missed big problems at the institution, including those involving John Parsons, a supervisor of a mortgage processing center and a methamphetamine addict. Parsons told the New York Times in a jailhouse interview that his job was to churn out loans without regard to the borrower’s income or assets. And his drug problem was no secret, the Times said:

“In our world, it was tolerated,” said Sherri Zaback, who worked for Parsons and recalls seeing drug paraphernalia on his desk. “Everybody said, ‘He gets the job done.’”

“You would think they might have noticed that,” Wilmarth said. “How could they not have?”

The case of Darrel Dochow, the senior employee demoted in December over the backdated IndyMac documents, also summarizes the agency’s problems.

The Treasury Department’s inspector general concluded that Dochow approved an IndyMac strategy to overstate the strength of its financial condition, shortly before its failure in July, which cost the federal bank insurance fund nearly $9 billion. OTS also allowed other troubled banks to record capital infusions earlier than they had actually received them, which made them appear to be more financially viable than they actually were, the inspector general found.

It wasn’t Dochow’s first brush with trouble. Dochow was demoted from his position as head regulator of the Federal Home Loan Bank Board over his role in putting off for two years the shutdown of Charles Keating’s Lincoln Savings & Loan, which collapsed in 1989, one of the most well-known bank failures of the savings and loan crisis. McCoy said that keeping the thrift open was an unnecessary move that ended up costing taxpayers. “Lincoln did a huge amount of damage,” McCoy said.

The Federal Home Loan Bank Board was replaced by the OTS in 1989, as a move to tighten regulatory standards. Dochow and many other former employees, however, were hired on, McCoy said.

Dochow worked his way back up the bureaucratic ladder at OTS, and redeemed himself in 2006 by helping to persuade Countrywide Financial Corp. to switch its regulator from the OCC to the OTS, according to a Washington Post probe of the agency. The story described the OTS as having an “overly close identification with its banks.”

Aided in part by the Countrywide deal, Dochow was promoted to head of the agency’s western regional district by 2007, McCoy said, giving him the distinction of being at the center of two of the worst bank crises in recent history.

But OTS’s issues go beyond Dochow. As GW’s Wachter noted, the OTS competes with other regulators for its customers and relies on fees it charges the banks it oversees, giving it a problematic setup similar to that of credit rating agencies. Adding insurance companies into the OTS mix can only make things worse because of the secrecy and lack of openness regarding the TARP program, Wilmarth said. “There’s no transparency here,” he said.

But Ruberry, the OTS spokesman, said OTS unfairly gets tagged with responsibility for large bank failures, considering companies such as Citigroup and Wachovia, which are regulated by the Federal Deposit Insurance Corp., also would have failed, but were helped out by the government. Thrifts also were more vulnerable because of their emphasis on mortgage lending. “It hit the industry particularly hard,” he said.

He also said it wasn’t true that the OTS went easier on banks than other regulators did. The agency did the best regulatory job it could during the housing boom, considering the large majority of subprime loans were made by independent lenders, not OTS banks, he said. Congress, Ruberry added, will have to decide the agency’s future, but the OTS believes it has a necessary role in representing smaller, community banks.

Despite all the controversies, the OTS could end up surviving, McCoy and others predicted.

Pairing with insurance companies to rebuild its customer base could strengthen the agency and help it fend off reformers, McCoy said. And, as Ely pointed out, insurers have a well-funded lobby to come to the agency’s side.

“The insurance companies WILL try to defend the existence of the OTS,” McCoy said. “This is an agency fighting for its life.”

With the help of government bailout money and powerful friends, it just might succeed.