A Horse Designed by Committee is a…what?

by Jack Milligan


There’s an old saying attributed to novelist Franz Kafka that a camel is a horse designed by a committee, and that’s an apt description of how this country’s financial system is regulated. There are four prudential agencies that are responsible for regulating insured depository institutions for safety and soundness: The Office of the Comptroller of the Currency, the Federal Deposit Insurance Corp. and the Federal Reserve regulate banks and thrifts, while the National Credit Union Administration watches over federally chartered credit unions. The Consumer Financial Protection Bureau, which was created by the Dodd-Frank Act and just celebrated its fourth birthday, polices the retail financial services market. And the Securities and Exchange Commission and Commodity Futures Trading Commission cover the broad capital, futures and derivative markets.

And there you have it – a system of regulation by committee.

This is not a rational approach to regulation for such a massive, and massively important industry as financial services, and it certainly is not how one would design the system today if starting from scratch. And that is exactly what former Fed Chairman Paul Volcker is proposing to do – to start over. Volcker and two former treasury secretaries, Timothy Geithner and Henry M. Paulson Jr., have stated publicly the view that regulation by committee was a significant enabling factor behind the 2007-2009 financial crisis. For example, unregulated nonbank mortgage origination companies helped drive the subprime mortgage lending boom by engaging in many of the now-discredited practices, like negative amortizing home loans and loans that did not require income verification, that ultimately led to the market’s noisy collapse.

The Dodd-Frank Act attempted to address many of the weaknesses in the financial regulatory structure, including the fact that the banking industry was undercapitalized. It created the CFPB, which does extend some measure of regulatory oversight to nonbank financial companies, at least in terms of the products they sell and how they sell them. And it eliminated the Office of Thrift Supervision, which was seen as a weak sister among the regulatory agencies that were overseeing insured depository institutions.

But DFA did very little to rationalize and simplify the regulatory framework. In fact, the law made things even more complicated. While it did sack the OTS, it also begat the CFPB which shares its oversight function with the FDIC, OCC and Federal Reserve. The CFPB makes the rules and supervises banks and thrifts over $10 billion in assets while the other agencies are responsible for consumer compliance at institutions under $10 billion, so there is still great duplication of effort. And it also created the Financial Stability Oversight Council, whose job is to identify and monitor systemic risks in the economy as they arise from large financial institutions. There are 10 voting members on the council including all of the aforementioned agencies, so basically it’s the same cast of characters meeting — yes! — in committee.

There have been countless proposals over many decades to reform the system, and the most recent one came from Volcker himself, who formed the Volcker Alliance in 2013 in hopes of bringing order to chaos. The Alliance, which is comprised of a star-studded cast of Washington worthies including former FDIC Chairman Sheila Bair and former Sen. Bill Bradley, released an ambitious proposal in April that would truly be a sweeping reform of the financial regulatory structure if ever enacted.

At the risk of significant oversimplification, because this is an expansive proposal, the Volcker plan would create a new super agency to assume the prudential supervisory duties of the OCC, FDIC, Federal Reserve, SEC and CFTC. The Financial Stability Oversight Council – or FSOC, which always reminds me of “sock it to ‘em’” — would have its responsibilities for systemic regulation greatly expanded. And the SEC and CFTC would be merged.

There has been little if any action on the Alliance blueprint since it was released four months ago, and I would be truly surprised if anything ever comes of it. Financial regulatory reform is a tough sell in Washington because it is complicated, because it doesn’t have great political sizzle, and because the regulatory agencies themselves fight like wildcats to preserve their turf. Elizabeth Warren, the Democratic senator from Massachusetts, has introduced legislation to reinstate certain Glass-Steagall Act provisions that would re-separate some commercial and investment banking activities. But I am not aware of anyone in Congress who has stepped forward to champion the Volcker proposal.

In truth, the best opportunity to reform the regulatory framework would have been just after the financial crisis, when Congress was focused on the passage of Dodd-Frank. Six years later, no one in Congress is talking about the financial crisis except, perhaps, for Warren. The next presidential campaign cycle is in full swing and Congress seems much more interested in debating the Iran nuclear deal, or trying to defund the Affordable Care Act and Planned Parenthood, or preserve the right to fly the Confederate battle flag in national cemeteries than regulatory reform.

I am reminded of the famous quote that then-Defense Secretary Donald Rumsfeld uttered during the Iraq War. “You go to war with the army you have. They’re not the army you might want or wish to have at a later time.” I strongly suspect that when the next financial crisis hits, we will go to “war” with the committee system we have today and not the better system we might want.