As more attention has been given to the financial reform debate, various people have been writing essentially the same column about the terrible recent record of regulators using their powers, and why that makes the bills in the House and Senate problematic since they give too much discretion to regulators to set prudential standards for banks, making it less likely that they will limit the risk of systemically important firms. It's an old argument for those of us who have been following the debate, but it's important to consider the role of regulators and where we can find the most direct way to solve that problem.
Number one, there are some good reasons for giving regulators discretion. While capital requirements may seem straightforward at first, there are numerous ways of assessing capital reserves -- risk-based capital, different tiers from the Basel agreements, and contingent capital are all different ways to conceptualize the issue, not even to mention accounting-standards questions that underlie the whole process -- and capital requirements are only one of several different variables that make up a firm's risk profile. (And, since there's been some misinformation on this front, there is a difference between capital reserves and leverage requirements; the House Financial Reform bill set leverage at 15 to 1 but didn't specify capital requirements.)
So while setting hard floors in statute is a good idea, pretending that those floors will prevent poor regulation isn't right, either -- it cannot be made "fool resistant." It's a bit like being asked to write a criminal code with the knowledge that the cops are corrupt; no matter how you structure your incentives, you still need to deal with the personnel problem. That's why more effort needs to be focused on improving the quality of regulators themselves rather than pretending we can write the perfect statute to guide even the most pernicious free marketeer toward shutting down a failing bank at the right time. Even worse, congressional statutes won't keep pace with the financial industries' efforts to "innovate."
Obama's appointments in this respect have been relatively strong. Keeping Sheila Bair at the FDIC, even in the fact of criticism from Geithner, was smart. Mary Schapiro, who replaced the incredibly bad Chris Cox at the SEC, was initially thought to be problematic but has showed real interest in improving the agency's resources and issuing tough new rules. Gary Gensler at the CFTC has fought hard on derivatives regulation, and while renominating Ben Bernanke was a bad decision, appointing former Georgetown law professor Dan Tarullo to be the Fed's chief banking regulator was a smart move. With more appointments coming up this summer, including the chance to replace John Dugan as comptroller of currency and perhaps appoint the president of the New York Fed, we can hope for even better people in those seats.
Almost all of these people are better than their Bush-era predecessors, but still more organized political attention needs to be paid to these appointments. We can't escape the fact that if an administration, like the previous one, comes to power and doesn't want to enforce the new regime, with few exceptions -- a Volcker-type rule that limits the scope of bank's businesses is a better venue for hard-and-fast statutes than prudential requirements -- it will be hard to avoid bad regulation in banking just as it is hard to avoid in environmental or labor issues. You just can't take the politics out of politics.
One thing that could be done now to improve our regulatory regime, besides more focus on appointments, would be an amendment to the Senate financial reform bill, the "Regulatory Force Modernization Amendment," or some such thing. It would bump up regulator and bank examiner salaries, provide more training opportunities, hire more diverse staff (read the Epicurean Dealmaker) and, hell, give them badges and an ethos. If we're serious about improving our regulatory institution, we need to come at the problem from all angles.
-- Tim Fernholz
