The Dodd-Frank Act has placed unprecedented responsibilities on the financial regulators to ensure financial stability and bank safety and to promote consumer protection. Many commentators have been skeptical of the reforms contained in the Act for this reason: after all, weren’t regulators part of the problem to begin with? So it is critically important that the new regulatory structure be endowed with strong and committed leadership. Not only will the performance of each agency depend on this leadership, but the synergy among agency heads in the new Financial Stability Council will also have to be well nigh amazing if the Council stands a chance of preventing another major financial crisis.
Among key areas to watch is the role of the Fed. Defying all odds, the Fed has survived immense public criticism for its management of the financial crisis and now gained enormous additional powers. The leadership abilities of its chairman, Ben Bernanke and key governors such as Daniel K. Tarullo are going to be tested to the limit. Another critical regulatory appointment is the head of the much debated new Consumer Financial Protection Bureau (CFPB) which, though housed in the Fed, will enjoy a great deal of independence. Here the fight over who will be nominated has already played out prominently in the media, with the Treasury Department apparently doing what it can to prevent Elizabeth Warren, the obvious choice for her knowledge, commitment and courage, from becoming the head of this agency. We should not underestimate what is at stake here, ably analyzed by John Talbott. To start out with an agency that is already captured by the industry would be a tragedy.
But keep in mind that other agencies are also critical. The FDIC, for example, has also acquired extensive new resolution powers, adding to its existing receivership powers for banks, to wind up non-bank financial institutions (think AIG and Lehman Brothers). Here the good news appears to be that an effort to bypass Elizabeth Warren by recruiting the current and extraordinarily able and independent-minded head of the FDIC, Sheila Bair, has failed, indicting that Ms. Bair will stay on as head of the FDIC.
Also acquiring broad new powers is the Office of the Comptroller of the Currency (OCC). The OCC, one of the nation’s oldest and most venerable agencies, carries a greater burden of responsibility than ever before in supervising large financial institutions, despite having taken considerable though sometimes unfair criticism for its role in the buildup to the crisis. Like the head of the new CFPB (in the Fed), the Comptroller is an independent appointee of the President even though his or her office is located within the Treasury Department. The Comptroller charters national (federally chartered) banks and, under the new legislation, will also do the same for federally chartered savings and loan associations. In effect, the OCC is the primary regulator for the banks that form the inner cores of the largest financial conglomerates in the nation and those that pose most risk to financial stability. While it will be the job of the Financial Stability Oversight Council to detect the rise of systemic risks generated by such conglomerates, expert, day-to-day supervision of these banks will remain most likely to ensure their safety and soundness and prevent problems from getting out of control–and this will be the job of the OCC. It is therefore critical that the new Comptroller have a deep understanding of the banking system and the experience to ensure effective supervision.
Yet the trap we keep falling into with economic regulation is regulatory capture: the closer the regulator becomes to the industry the more likely he or she is also going be biased in favor of that industry. As the French say, “to understand all if to forgive all.” Independence and strong, experienced leadership is going to prove critical if the OCC is to regain its historical tradition as one of the nation’s premier regulatory bodies.
So watch for the nomination of the new Comptroller of the Currency. The choice to replace John Dugan, who leaves in a few days, will be one of many indicators whether the new financial reform legislation is going to have any meaningful impact on our severely damaged financial system. I have advocated elsewhere that it is important to appoint an experienced but independent and highly intelligent regulator to this role (in other words, a qualified outsider). Two obvious possibilities exist and both present the ideal combination of outsider experience, records and knowledge are North Carolina Banking Commissioner Joseph A. Smith, Jr., and New York Banking Superintendent Richard H. Neiman. New York and North Carolina are the nation’s two most prominent banking states. Both regulators supervise very large institutions and would not be daunted by the challenges facing the newly combined Comptroller’s office. Both are highly respected by their industries and both have credibility in the arena of consumer protection. In addition, both bring to the table another dimension that has been largely escaped public attention. Commissioner Smith, as immediate past chair of the Conference of State Banking Supervisors, has been spokesman for the important other, state chartered, part of our banking system, and Superintendent Neiman holds high office in the Conference.
The Dodd-Frank Act turns the spotlight onto the regulators with an intensity seldom seen in economic regulation. Can we realistically hope that regulators will perform better than they have in the past? To stand any chance that things will change, we are going to need strong, visionary regulators who are not enamored of the virtues of banking at all costs, who understand the harm powerful financial institutions can wreak if not effectively regulated while also working with industries that are vital to our prosperity, and who are able to adapt to new, more effective forms of regulation. This is a very tall order. The coming days will reveal the Administration’s nominees and the choices will be a good indication of how effective the Dodd-Frank reforms are likely to prove.