Will Financial Regulatory Reform Prevent Future Financial Crises?

Will Financial Regulatory Reform Succeed?

In an assessment of the proposed changes to the financial regulatory system, one expert expects the changes to be more evolutionary than revolutionary.   Robert Pozen, chairman of MFS Investment Management and senior lecturer at Harvard Business School, summarized his viewpoints in a Barron’s article.

Banking Agencies

Instead, Congress is likely to merge the Office of Thrift Supervision into the Comptroller of the Currency, creating one agency to regulate all nationally chartered banks and thrifts. The FDIC will continue to supervise small state-chartered banks, and the Fed will oversee large state-chartered banks.

Consumer Financial Protection Agency

As proposed by Treasury, the CFPA would have jurisdiction over all financial products offered to retail customers — including savings products, credit cards, mortgage loans, custodial services and debt-collection services.

The CFPA is likely to become the federal agency that regulates mortgage originations, which were poorly handled in the past by the Federal Reserve and the states. The CFPA also should regulate financial products and services provided primarily by nonbank lenders, especially to lower-income families, such as payday loans and debt-collection services.

Systemic-Risk Regulator

The Treasury has proposed that a council of eight regulators become the monitor of systemic risk. This council would be an expanded version of the existing President’s Working Group on Financial Markets. In addition, the Council would recommend the designation of certain firms as “systemically risky institutions [SRIs],” which would then make them regulated primarily by the Fed.

But group monitoring potentially would leave no one with responsibility.

Congress is expected to authorize the FDIC to choose among multiple resolution alternatives, such as a bridge bank or conservator, in dealing with any SRI that becomes insolvent. The FDIC has more flexibility than the all-or-nothing approach of the bankruptcy code. Today, however, the FDIC only has jurisdiction over insolvent banks, not broker-dealers or even bank holding companies.

In short, although many politicians initially called for a fundamental restructuring of financial regulation, legislative reforms will be more evolutionary than revolutionary. Despite lots of talk about streamlining, the number of financial agencies will remain exactly the same — with the elimination of the Office of Thrift Supervision and the addition of the CFPA.

Same Players – Same Outcome?

If Mr. Pozen’s assessment is correct, the financial system will remain regulated by the same overlapping set of regulatory agencies that we now have.  In a recent speech regarding the need for financial regulatory reform, Sheila Bair, FDIC Chairman, noted that regulatory gaps and lax supervision were major contributors to the financial crisis.  In addition, Ms. Bair noted that regulators often could not be distinguished from the bankers that they allegedly regulated.

Despite the hype about financial regulatory reform, it now seems likely that the same regulators who failed in the past will now be expected to prevent the next financial crisis – not exactly a comforting nor plausible scenario.