The Volcker Alliance, a trade association founded by Paul A. Volcker, released a report titled “Reshaping the Financial Regulatory System.” The report calls for “long delayed” reforms and outlines recommendations for a “stronger” financial regulatory framework.
According to the report, the system for oversight of the financial system is a framework that is riddled with “regulatory gaps, loopholes, and inefficiencies” and developed in a “piecemeal fashion.” The report notes that developments in financial markets have outpaced those of the current regulatory framework, causing it to be under “significant strain.” The report also identified structural “deficiencies” highlighted by the financial crisis, including the following:
- parts of the financial system remain insufficiently regulated or unregulated, and not well understood;
- significant forms of risk have migrated to less-regulated or unregulated parts of the financial system;
- the effectiveness of prudential supervision for certain large market participants, such as broker-dealers and derivatives clearing organizations (“DCOs”), remains uncertain;
- certain agencies remain under-resourced even as their responsibilities have grown exponentially; and
- the multiagency framework fuels interagency tension, causing communication and coordination problems at home and abroad, and fostering a lack of accountability.
The report recommends reorganizing the current regulatory system to create a “simpler, clearer, more adaptive, and more resilient regime.” The report’s recommendations are guided by three broad objectives: (i) oversight and surveillance, (ii) supervision and regulation, and (iii) investor protection and capital market conduct. Other recommendations from the report include the following:
- establishing a Systemic Issues Committee of FSOC that could designate systemically important financial institutions and would be composed of the chairs of the Federal Reserve, the Federal Deposit Insurance Corporation and a newly created Investor Protection-Capital Market Conduct Regulator; the directors of the Federal Housing Finance Agency, the Consumer Financial Protection Bureau and the Office of Financial Research; and a state insurance commissioner designated by the state insurance commissioners;
- removing the Office of Financial Research from the Department of Treasury to create an independent entity that would be required to collect, compile and standardize data;
- eliminating the Office of the Comptroller of the Currency; and
- merging the SEC and CFTC to create an investor protection and capital market conduct regulator.
Lofchie Comment: The Volcker Alliance’s criticism of financial regulatory structure provides an excellent excuse to initiate a much needed discussion and debate about our regulatory framework.* In the interests of fostering that debate, here are a few areas of disagreement regarding what Mr. Volcker has to say about the cause of the problems as well as their proposed solutions:
Were I but King and Master of the Universe. Mr. Volcker’s thesis is that the U.S. government failed to anticipate and head off the financial crisis because it just didn’t have enough power, and even when it did, that power was not sufficiently concentrated in a single agency or person (see page 17). Given the nature of human frailty and imperfection, the argument that the solution to governmental failure is to provide the government with more power, and to make that power more concentrated, is unsound. Mr. Volcker’s argument would have more force if he were able to show, for example, that the Board of Governors of the Federal Reserve was trying desperately to shut down the housing bubble before the financial crisis. Sadly, it was not. Here, for example, is a link to a speech by former Federal Reserve Board Chairman Greenspan, in which he acknowledged that while the rate of increase in housing prices may have slowed, he was not especially concerned. The purpose of linking to this speech is not to point a finger at Mr. Greenspan, but rather to take issue with the notion that the answer to ignorance about the future is to create a single mighty regulator.
Let’s All Agree, but Not Indulge in Groupthink. Apparently, Mr. Volcker would place the Financial Stability Oversight Council at the top of his new regulatory pyramid. Even so, he does not like certain aspects of FSOC. For example, he thinks that FSOC is “too divided” to provide a “comprehensive, forward-looking view” or to “take decisive and timely action.” Additionally, he regrets FSOC’s ability to “require” other regulators to adopt rules that it would prefer to mandate. However, in what seems to be an utterly contradictory statement, he says that “the regulatory system must contain effective safeguards to ensure the independence of the responsible agencies; reduce the risk of group think; and guarantee a broad perspective in governance and decision-making” (at page 4).
We Are All Banks (and Should Be So Regulated). Mr. Volcker observes that non-banks now “hold two-thirds of all credit-market assets” (at page 1). The corollary of this observation is that these “shadow banks” are “potentially unstable” and “create a risk of contagion,” and so presumably should be regulated as if they were banks. Contrary views are possible: Isn’t it a good thing that credit is held outside of banks? Doesn’t that allow greater diversification of risk than if all credit assets were held inside of banks? Isn’t part of the reason that so much credit is held outside of banks because banking regulators have made offering loans much more expensive for banks? Since they’ve effectively pushed so much lending activity outside of banks, should the bank regulators really be given regulatory authority over all other lenders?
The Supremacy of the Banking Regulators at FSOC. The slightly reorganized version of FSOC at the top of Mr. Volcker’s regulatory pyramid would be dominated by banking regulators. At least five of the six members, and potentially all, would come from a single political party (although FSOC would be, according to Mr. Volcker, “non-partisan”). It is not that the banking regulators are unwise; the bank regulators have the most intellectual culture among all U.S. regulators. The problem is that they see the world through a bank regulator’s lens. They want to dictate not just what banks can own, but what non-banks can own; they want to control the risks taken not just by banks, but also by non-banks; and they want to control borrowing and leverage by banks and non-banks as well. But we are not all banks. Other imperatives exist besides freedom from risks, including the freedom to take risks.
The Volcker Alliance Report challenges us to have a real and important debate about fundamental structural issues. Congress should take up this challenge. As to his solutions, the above commentary identifies two principal points of disagreement. First, Mr. Volker’s advocacy for “safety” above opportunity presents great dangers. His structural solution, to give a concentrated dominant role to the bank regulators should be subject to significant scrutiny. Second, implicit in Mr. Volcker’s position is his advocacy for greater control and discretion for the government regulators of private entities. That solution ought not to be accepted even if proposed by a wise man. It is possible to revisit our system of financial regulation and improve it without the expansion of governmental power that Mr. Volcker envisions.
*One may want to begin the discussion by linking to two articles (humbly submitted) by a different author: “The Future of Financial Regulation” and “Some Concerns with the Derivatives Legislation.” These two pieces anticipate some of the Volcker Alliance’s observations (by seven years) and offer a private citizen’s view of the workings of government regulation.