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Tuesday, June 09, 2009

Regulatory "Interagency Turf War"

From Free Exchange, a follow-up to the post below this one on regulation of the financial industry:

VIA Kevin Drum, comes this, from the Wall Street Journal:

The Obama administration is backing away from seeking a major reduction in the number of agencies overseeing financial markets, people familiar with the matter say, suggesting that the current alphabet-soup of regulators will remain mostly intact.

....The administration, for example, is unlikely to call for merging the Commodity Futures Trading Commission and the Securities and Exchange Commission, an idea it had considered, these people say. It also isn't expected to call for the Federal Reserve, Federal Deposit Insurance Corp. or the Office of the Comptroller of the Currency to cede their primary authority to supervise banks, they say....Officials worry that trying to start from scratch could ignite messy turf battles that might slow or even derail the entire process.

I could understand a situation in which regulatory changes which needed to be approved by Congress faced constraints based on the banking industry's political leverage in Washington. But an inter-agency turf war? What power do these agencies have over the decision makers in the government? What constituency is going to rise up and defend the right of the Office of the Comptroller of the Currency to continue regulating some subset of financial firms?

If it is outside interests who believe they stand to lose from reorganisation, then that makes sense, but that's not what the Journal is reporting. Colour me confused.

Me too. Small, fractured regulatory authority is no match for too big and too interconnected to fail institutions.

The problem with multiple regulatory authority, or one problem anyway, is that firms can shop around for the lightest regulation, then do their best to redefine what they do through creative financial engineering until it fits under the less restrictive umbrella (and prior to the crash, firms did just that). In addition, they also put pressure on both legislators and regulators to support those redefinitions. The result is, essentially, regulatory capture through arbitrage and less than effective regulation. The same forces that cause the turf war described above will also cause agencies to compete for regulation business to increase the agency's importance and prestige, and the process bids down the level of regulation below acceptable levels.

Update: From comments:

The first half of last week's This American Life captured the regulatory shopping angle quite well. The Office of Thrift Supervision made itself so appealing that GE, GM, and AIG each opened up a thrift so that their whole company would be regulated by OTS. OTS was the agency that had the famous chainsaw press conference (see bottom of CR blog post).

    Posted by on Tuesday, June 9, 2009 at 11:18 AM in Economics, Politics, Regulation | Permalink  TrackBack (0)  Comments (13)


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