Shopping For Regulators

Last March, Barack Obama gave a good speech on the subprime crisis in which he made a very important point:

“We need to regulate institutions for what they do, not what they are. Over the last few years, commercial banks and thrift institutions were subject to guidelines on subprime mortgages that did not apply to mortgage brokers and companies. It makes no sense for the Fed to tighten mortgage guidelines for banks when two-thirds of subprime mortgages don’t originate from banks. This regulatory framework has failed to protect homeowners, and it is now clear that it made no sense for our financial system. When it comes to protecting the American people, it should make no difference what kind of institution they are dealing with.”

There’s a story in today’s Washington Post that makes it clear why this matters:

“When Countrywide Financial felt pressured by federal agencies charged with overseeing it, executives at the giant mortgage lender simply switched regulators in the spring of 2007.

The benefits were clear: Countrywide’s new regulator, the Office of Thrift Supervision, promised more flexible oversight of issues related to the bank’s mortgage lending. For OTS, which depends on fees paid by banks it regulates and competes with other regulators to land the largest financial firms, Countrywide was a lucrative catch.

But OTS was not an effective regulator. This year, the government has seized three of the largest institutions regulated by OTS, including IndyMac Bancorp, Washington Mutual — the largest bank in U.S. history to go bust — and on Friday evening, Downey Savings and Loan Association. The total assets of the OTS thrifts to fail this year: $355.7 billion. Three others were forced to sell to avoid failure, including Countrywide.

In the parade of regulators that missed signals or made decisions they came to regret on the road to the current financial crisis, the Office of Thrift Supervision stands out.”

Most of the article, which is really worth reading, deals with OTS and its regulatory failures. But beyond that, it should not be possible for banks to go shopping among several different regulators, seeing which would offer them the friendliest and most relaxed oversight. That wouldn’t be possible if banks had to make real changes to move from one regulatory body to another: if we regulated institutions for what they do, not what name they choose to call themselves.

But if we must have an enormous mass of regulatory bodies that banks can switch in and out of without major changes in their business models, can we at least not have them funded in ways that give those agencies incentives to try to attract banks by offering more lenient oversight?

“Angelo R. Mozilo, then the chief executive of Countrywide, approached OTS about moving out from under the supervision of the Office of the Comptroller of the Currency, which regulates national commercial banks. (…) Senior executives at Countrywide who participated in the meetings said OTS pitched itself as a more natural, less antagonistic regulator than OCC and that Mozilo preferred that. Government officials outside OTS who were familiar with the negotiations provided a similar description.

“The general attitude was they were going to be more lenient,” one Countrywide executive said. For example, he said other regulators, specifically OCC and the Federal Reserve, were very demanding that large banks not allow loan officers to participate in the selection of property appraisers. “But the OTS sold themselves on having a more liberal interpretation of it,” the executive said.

Winning Countrywide was important for OTS, which is funded by assessments on the roughly 750 banks it regulates, with the largest firms paying much of the freight. Washington Mutual paid 13 percent of the agency’s budget in the fiscal year ended Sept. 30, according to OTS figures. Countrywide provided 5 percent. Individual firms tend to make a larger difference to OTS finances than other bank regulators because the agency oversees fewer companies with fewer assets.”

That’s a truly stupid funding mechanism. Personally, I’d prefer that taxpayers pay for government agencies. But if we must fund them by levying fees on industry, we should at least try levying fees on the financial industry as a whole and funding the various regulatory agencies out of one common pool of money. That would remove agencies’ incentive to try to attract banks by giving them what they want. And giving banks what they want is not what regulators ought to be doing.