Ezra reads Felix Salmon on the administration's new financial regulation proposal:

Felix Salmon is right: This sort of financial regulatory arbitrage is some impressively repulsive stuff. And the White House's proposed reforms won't fix it.

But Ezra is wrong: the White House's proposed reforms were specifically designed to fix the type of regulatory arbitrage that Salmon is talking about. Salmon doesn't even suggest that the WH's reforms won't fix the problem; he just notes that a different kind of problem might arise from the fix -- and it's a much less pernicious one.

See, financial institutions can choose which regulators will be their primary supervises. Depository institutions, state and national, are regulated by the FDIC, but national commercial banks can come under the authority of the Fed, the Office of the Comptroller of Currency and the Office of Thrift Supervision (and this is a simplified version). OCC and, to an even greater extent, OTS, were known as lax regulators. Countrywide Home Loans famously switched to a thrift charter in 2007 because it offered weaker capital requirements and greater federal preemption over state regulators seeking to stop predatory mortgage lending. But the administration would eliminate the OCC and the OTS and consolidate them into a National Bank Supervisor.

This would eliminate the pernicious competition between the two agencies and give national banks a single primary regulator. True, this may result in competition between the FDIC and NBS for national banks that have depositors. But given that the FDIC is a stronger regulator than most (go Sheila Bair!) that has primary jurisdiction over any deposits, and there will be a primary regulator for any non-depository national banks, it strikes me as much less of a problem. Whereas previously a Countrywide or an AIG could pick and choose between regulators, under the new proposal, they would likely have to go to the NBS. They would also be likely to receive even more supervision from the Fed under the new rules for systemically risky institutions.

That's not to say all problems of regulatory arbitrage (or even all problems with the financial sector) were eliminated by the President's plan. In particular, the Securities and Exchange Commission and the Commodities Futures Trading Commission both have jurisdiction over derivatives that will prove very difficult to fix in practice; working out how the new council of regulators will work with the Fed in its systemic risk monitoring role will also be a huge challenge. But the elimination of the OCC and the OTS and the creation of the NBS are among the high points of the plan, and aim to fix exactly the problem Ezra is describing.

Further Reading: Who will regulate the regulators?

-- Tim Fernholz

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