Paulson's big bang

Paulson’s dropped his controversial bomb on Washington – a plan to overhaul financial regulation. Gone would be the SEC, FDIC, CFTC, OTS and OCC. In their place would be the Prudential Financial Regulatory Agency (replacing the OCC and OTS), the Conduct of Business Regulatory Agency (taking over consumer protection functions of the SEC and CFTC, as well as some state insurance regulation), the Federal Insurance Guarantee Corporation (replacing the FDIC and taking over the federal government’s newfound role as an insurance guarantor) and the Corporate Finance Regulator (taking over the SEC’s disclosure, accounting and governance regulatory functions).

Now, try to swallow that.

Here’s the executive summary, a general WSJ article (with lots of links to other WSJ coverage), and Gordon Smith’s summary. The large questions include the regulatory competence of this new structure (including the loss of the institutional competence of the replaced agencies); whether this amounts to an excessive federal takeover of state authority; and whether we’ll be losing significant flexibility along with the hoped-for rationalization.

On this latter point, consider that the CFTC's replacement, CBRA is likely to be less accommodating . Sure we won’t have anymore turf wars like the one Judge Easterbrook adjudicated in Chicago Mercantile Exchange v. SEC, 883 F.2d 537 (7th Cir. 1989). However, with one regulatory agency we’re likely to get fewer new financial products. Harvard's Hal Scott is quoted in the WSJ article as saying that we don't want a competition in laxity between agencies.  But what is the optimal amount of laxity?  Can we assume that government are acting appropriately when, for example, they squelch new products?

On the state-federal issue, the big issues concern insurance. I’ll have more to say about that in my next post.

A big problem here is that this overhaul is being proposed in the midst of a financial crisis -- the sort of thing that's given us the whole misguided patchwork the new system wants to replace (think SOX). Glenn Hubbard comments for the WSJ along these lines.  But another way to look at this is that putting all this in a huge hard-to-digest package may have the salutary effect of deferring any regulation until after the crisis has passed.

I’m hoping we we don’t make an even bigger mistake when things calm down.

Comments

[Elizabeth Brown]

Larry, Thank you for the kind comments about my scholarship in your post on insurance. I also think that the Searle Center has organized a very timely and interesting conference.

While Paulson's proposed reforms would be dramatic shift for the United States, they are not untried. Almost nations now use either a single agency or a semi-integrated agency to regulate financial services, including some of the biggest competitors of the United States such as the United Kingdom, Germany and Japan. Consolidating our regulators poses both benefits and problems, which I have outlined in some detail in my article on creating a single US Financial Services Authority available at SSRN: http://ssrn.com/abstract=757010

[M.D. Fatwa]

I would love to work for a government industry policing agency called "CoBRA". I bet they'll even get to wear cool uniforms.

[Fat Man]

In a new chapter of the Washington DC game popularly known as rearrange the deck chairs on the Titanic, Sec. Paulson ...