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U.S. May or May Not Establish a Single Banking Regulator

The Washington Post, this morning:

Senior administration officials are considering the creation of a single agency to regulate the banking industry, replacing a patchwork of agencies that failed to prevent banks from falling into the worst financial crisis since the Great Depression, sources said.

Bloomberg, today:

House Financial Services Committee Chairman Barney Frank ruled out creating a single U.S. bank watchdog similar to the U.K.’s Financial Services Authority as part of an overhaul of regulations.

Failure to communicate? Not necessarily. Both the administration and Frank seem interested in combining the responsibilities of the Office of the Comptroller of the Currency, the Office of Thrift Supervision, and the Federal Deposit Insurance Corporation into a single banking regulator, and both seem to favor a separate regulator, likely the Federal Reserve, to focus on systemic risk. The difficult question, as I see it, is whether this division makes sense.

On the one hand, two separate regulators overseeing the health of the banking system provides an opportunity for redundancy. Should the Federal Reserve fall into the hands of a laissez-faire ideologue (difficult to imagine, but play along) then a separate regulatory agency overseeing banks could take steps to shore up capital buffers and limit risky activities at systemically important institutions. The system might have functioned this way before the current crisis, were banks not in a position to shop among multiple regulators (OCC, OTS, FDIC), which created an incentive for the regulatory bodies to compete for banks.

On the other hand, having dual regulatory agencies creates the potential for a lot of buck-passing. Pulling away the punch-bowl is not popular. Bubbles make a lot of people very (though temporarily) rich, and those people will command a lot of political influence, which will be marshaled to fight any attempt to enforce sobriety. The systemic regulator could be tempted to declare problematic issues the purview of the banking regulator, and vice versa.

It’s important to have a place where the buck definitively stops, and a few carcasses which can be nailed to the wall in the event of a major regulatory failure. That’s currently difficult to do, because so many potential overseers fell down on the job. Deny the regulator any scapegoat, and the regulator is more likely to do his job effectively.

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