BankThink

Volcker's Call for Regulatory Reform: Smart and Unlikely

A recent American Banker article asks whether former Federal Reserve chairman Paul Volcker's proposal to consolidate the U.S. regulatory system will gain traction. If history offers any indication, the answer is no.

By recognizing that the U.S. bank regulatory system is broken, Volcker officially and quite belatedly joins a long line of advocates for reform. In fact, the venerable Volcker is not even the first former Fed chairman to observe that the regulatory system is in need of a common-sense makeover.

On April 21, 1974, Arthur Burns, who then served as the head of the Fed, spoke at the American Bankers Association convention in Honolulu, Hawaii. Burns had this to say about the regulatory system:

"I must say to you, however, that I am inclined to think that the most serious obstacle to improving the regulation and supervision of banking is the structure of the regulatory apparatus. That structure is exceedingly complex."

Burns went on to say that it "boggles the mind" that "our system of parallel and sometimes overlapping regulatory powers is indeed a jurisdictional tangle."

Perhaps inspired by Burns, the U.S. Senate Committee on Governmental Affairs in 1977 issued a report that characterized the regulation of commercial banking in the U.S. "intricate, labyrinthine, baffling, and remarkable."

"Undeniably, it contains seeds of a significant amount of overlap, duplication, and inconsistency," the report said.

In 1986, former Federal Deposit Insurance Corp. chairman Irvine H. Sprague expressed even more frustration with the regulatory system in his book Bailout.

"Confusion is rampant," he wrote. "The basic function of the three supervisors is the same … In my judgment, a consolidated Independent banking agency should be created with the responsibility of regulating and supervising all banks and their holding companies, regardless of their chartering authority for Fed membership."

In my estimation, Sprague's book is the most important book written about banking in the past century. Even though he brilliantly diagnosed the broken regulatory system, his book has not received the readership it deserves because of his association with the banking crisis of the 1980s as well as his pull-no-punches observations about the "running turf fight" among regulators. He described former Comptroller of Currency Jim Saxon as the "consummate turf protector."

Apparently there is something to Sprague's comments on regulatory turf wars, because at least four other former regulators have written on this topic.

William Seidman, an FDIC chairman under the Reagan administration, offered these insights about bank regulators in 1993 in his book, Full Faith and Credit:

"No activity is followed with greater interest in Washington, D.C., than the battle between various agencies for 'turf.' Turf is a euphemism for power, and particularly for the power achieved in gaining additional control and responsibility at the expense of rival agencies. In order to understand the U.S. banking system, it is necessary to describe the various regulators' area of responsibility, which represent a constant temptation for them to defend their respective turf."

Another former FDIC chairman under Reagan, William M. Isaac, also commented on regulatory turf battles in his 2010 book, Senseless Panic:

"I supported strengthening the examination and enforcement capabilities of the FDIC and the other bank regulators. Many bankers objected, as did the other agencies when they thought the FDIC was encroaching on their turf."

In contrast to Sprague, Isaac, and Seidman, all of whom came to the FDIC from outside the Washington power grid, Sheila Bair has been a Washington insider since joining Sen. Robert Dole's staff in 1981, just a few years after graduating from law school.

Despite Bair's deep Washington roots, even she grew exasperated by the broken regulatory system while serving as FDIC chairman under George W. Bush. She wrote in her 2012 book Bull by the Horns:

"The United States has gone too far in creating a plethora of regulators with responsibility for various pieces of the regulatory system. We do not have an efficient decision-making structure for them to collectively address systemwide problems. Each agency tends to focus on protecting its own turf."

Speaking of powerful Washington insiders, it's well-documented that Sen. Chris Dodd wanted to streamline the U.S. regulatory system as part of the Dodd-Frank legislation. Even he failed to make any progress.

Apparently the Obama administration also supported reform of the regulatory structure, according to former Treasury Secretary Timothy F. Geithner's 2014 book Stress Test.

"Our current oversight regime, with its competing fiefdoms and overlapping jurisdictions and perverse incentives encouraging firms to shop around for friendly regulators, was an archaic mess," he wrote. "Vast swaths of the financial system had no one in charge." Geithner predicts that this structure "will slow the regulatory system's ability to evolve in response to future market innovations."

Lest anyone think that Dodd-Frank did anything to fix the broken regulatory structure, check out the Federal Reserve Inspector General's October 2014 report about JPMorgan Chase's "London Whale" trading scandal. The report highlighted "poor coordination" between the Fed and the OCC. It also cited "turf battles" and accusations of "territorial" behaviors. Some things never change.

As I wrote in my own book, the U.S. has the most poorly designed bank regulatory system in the world. For two centuries, politics has trumped progress. Over the past century, 18,200 banks have failed, including 500 since 2008. Until lawmakers get serious about their accountability for rectifying the broken system, the American people can be confident that sometime in the next 20 years or so, the U.S. will experience another devastating bout of financial crisis.

Will the fact that Volcker has added his voice to calls for an overhaul of the regulatory structure make a difference? Will Congress finally get to work fixing the regulatory system?

For an answer to these questions, refer to FDIC vice chairman Thomas Hoenig's recent op-ed in BankThink. In his closing paragraph, he makes it clear that he intends to protect the status quo: "Any proposal that weakens rules or consolidates regulatory agencies without attention first of conflicted structure of the industry and the quality of supervision is a distraction."

The wagons are already circling, Mr. Volcker. Good luck.

Richard J. Parsons is the author of Broke: America's Banking System. He is writing a new book about the future of U.S. banking.

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