Don’t Blame Competition between Regulators

This article appeared in Forbes on September 15, 2009.

Treasury Secretary Tim Geithner and congressional Democrats are calling for an end to competition between bank regulators, claiming that it contributed to the crisis. This claim, however, has almost no evidence to support it and much to the contrary. Washington needs to stop wasting valuable time on peeves unrelated to the crisis and focus on fixing the underlying flaws in the regulatory system.

The narrative in Washington is that competition among financial regulators allowed financial institutions to choose the weakest regulator, and also encouraged regulators to weaken their supervision and enforcement in order to attract more entities toward their charter. This drives the call by Democrat congressional leaders and the Obama administration for the elimination of both the Office of Thrift Supervision (OTS) and the Office of the Comptroller of the Currency (OCC), and their merger into a single "super" bank regulator.

But is this narrative more than mere assertion? Fannie Mae and Freddie Mac could not choose their regulator, nor could Bear Stearns or Lehman Brothers. The worst-performing U.S. institutions at the very center of the crisis had no choice in their regulator.

And of course, this was not simply a U.S. crisis. Northern Rock had no ability to choose its regulator. The U.K., like much of the world, does not have multiple bank supervisors, but only a single supervisor. In fact, only three developed countries have multiple bank supervisors: the United States, Germany and Liechtenstein. And only in the U.S. is there any real degree of competition between bank regulators. If this were a crisis driven by competition among bank regulators, then most of the world would have been spared.

Why then merge the OTS and the OCC? Apparently the proposal rests upon the observation that both AIG and Countrywide owned thrifts at the time of their failure. In addition, the failure of thrift IndyMac was one of the largest bank failures to date. Not long after came the failure of Washington Mutual (WaMu). Therefore, the OTS must have been the weak link.

However, both AIG and Countrywide acquired federally chartered thrifts late in the game; their failures were already "baked in the cake" long before they acquired thrifts. Their thrift subsidiaries were also very small parts of their balance sheets. And in neither case did their failure result from their thrift subsidiaries.

In relation to IndyMac and WaMu, the entities regulated by the OTS specialize in mortgage finance; hence it should not be surprising that in the aftermath of a housing bubble, those engaging in mortgage finance fail at a greater rate. More importantly, neither the failure of IndyMac or WaMu cost the taxpayer a dime. The market disruption from their failures was minimal.

Prior to the savings and loan crisis, when there really was a significant difference between bank and thrift charters, thrifts could not choose to maintain their current business model and also flip charters, yet that lack of regulatory competition did nothing to help avoid the S&L crisis.

The competition that does occur among bank regulators is the result of our dual state-federal banking system. However, Obama's proposal includes no mention of changing that dual system.

The real desire for consolidation is revealed in Secretary Geithner's regular attempts to silence the independent bank regulators. The different perspectives of Sheila Bair, John Dugan, John Bowman and Ben Bernanke have offered valuable insights into the regulatory debate. Silencing these voices will not help avert the next crisis, nor will it improve the quality of current reform efforts. Creating a single bank regulator, under the supervision of the Treasury secretary, would deprive Congress and the public of much needed diversity in views on bank regulation.

To the extent that concerns about charter shopping are valid, there is an easier and more effective fix than merging regulators: Require the FDIC to base deposit insurance premiums on the historical and expected losses by charter. One could also require the FDIC to base premiums upon the location of the bank as well. There's no reason for the rest of the country to subsidize the risky behavior of California-based mortgage lenders.

The administration should abandon its knee-jerk ideological opposition to competition and recognize that in many parts of our financial system, such as with Fannie and Freddie or with the credit rating agencies — it was the lack of competition, not its abundance, which contributed to the crisis.