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Wednesday, April 14, 2010

Political Appointees and Regulation of the Financial System

As we think about how to change the regulatory structure of the banking and finance industry, we should take note of this:

Kirsten Grind Blogging the WaMu Hearing, by Calculated Risk: Kirsten Grind at the Puget Sound Business Journal is blogging from the WaMu hearing. How about this quote?
"My opinion is the OTS examiner in charge during the period of time I was there did an excellent job of finding and raising issues. Likewise, I found good performance from the FDIC examiner in charge. What I can't explain is why the superior in the agencies didn't take a tougher tone with banks, given the degree of negative findings. My experience with the OTS and OCC (Office of Comptroller of the Currency, another federal bank regulator) was completely different, so there seemed to be a tolerance there or political influence of senior management of those agencies that prevented them from taking more active stances — I mean, putting banks under letters of agreement and forcing change." [James Vanasek, who was the former chief risk and credit officer of WaMu from 1999 to 2005]
We have seen this over and over. Every time the inspector general's office issues a report on a failed bank, the field examiners had correctly identified the problems - usually going back to 2003 or so - but no further action was taken.

Vanasek is arguing this was possibly because of "political influence of senior management of those agencies" - the political appointees in charge. I've heard the same thing from examiners.

Rules don't do any good if there is no will to enforce them. The culture within these agencies is every bit as important as the rules they are supposed to enforce. I've argued that many of the problems we are seeing could have been avoided simply by enforcing the rules that are already on the books. If that's true, then imposing new rules is not the entire answer. Some new rules are needed to deal with problems that did not exist and were not foreseen when the existing rules were formulated, but we need to pay more attention to how the rules are enforced, particularly who has responsibility if problems develop later due to lax enforcement.

Right now, as far as I can tell, there is little accountability. For example, perhaps it's happened, but have any of the senior management alluded to above been replaced because of their failure to enforce existing regulations? One answer to this problem is to replace discretion with strict rules, but that is not always possible, and strict rules can often be gamed, so some degree of discretion will always be present. Thus, it's important that discretion be coupled with accountability. It won't fix all of the problems, but more accountability for those with discretionary authority is essential. 

There is the problem of how enforcement will change with changes in the party in power, the rules may not be enforced to the same degree when Republicans are in power, and that is a difficult problem to overcome. Some of it can diminished be through institutional design that reduces the influence of political influence within the regulatory agencies, and we should think a lot more than we have about how to do that (e.g. with permanent staff), but I don't think this is a problem that can ever be overcome entirely. We cannot write rules specific enough to cover everything, so there will always be discretionary authority and that means there will always be a role for judgment. But we can surely do a better job than we have at removing such influence from the agencies charged with protecting our financial system.

    Posted by on Wednesday, April 14, 2010 at 11:26 AM in Economics, Financial System, Politics, Regulation | Permalink  Comments (13)


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