As huge problems crippled the mortgage markets during the winter, just about everyone agreed the system needed better regulation. But this spring, when U.S. Treasury Secretary Henry Paulson announced plans to concentrate more power in federal hands, William F. Galvin, the longtime Massachusetts Secretary of the Commonwealth, called them "absurd."
In his sweeping, 218-page blueprint for reform, Paulson contended that a confusing patchwork of rules had created "regulatory arbitrage" that made it impossible for regulators to keep pace with the frenetic change in the financial services industry. Companies kept exploiting cracks in the regulatory system until the mortgage market melted.
The answer, Paulson believes, isn't more or less regulation. Instead, he argues for a more transparent federal regulatory strategy and consolidation of federal regulatory power from five agencies into just one -- the Federal Reserve. Galvin replies that the problem wasn't the structure of the regulatory system but the failure of the feds to act fast enough.
Galvin insists he and aggressive colleagues in New York and other states had been far ahead of the feds, warning of the growing crisis and imposing tough remedies within their own borders. He says that "it is little use to the people if we wind up with a single watchdog -- and the watchdog sleeps." In his opinion, Paulson had merely bent to the will of lobbyists for the financial industry who favored federal control because they wanted "to make pesky state regulators go away."
Such nasty federal-state battles have plagued financial regulation since the epic struggle in the 1790s between Thomas Jefferson and Alexander Hamilton, the one that caused President George Washington to grind his wooden teeth to splinters. At that time, two central banks collapsed under worries that Eastern bankers would stifle credit for farmers. It took the banking collapse of the Great Depression, almost a century and a half later, to permanently establish the strong national role Hamilton had fought for.
Periodic crises have produced a patchwork of regulations that only lobbyists paid to navigate them could love. Some banks operate under state charters and state regulators, but the federal government has a hand in their regulation. The Fed regulates state banks that are members of the Federal Reserve System. The Federal Deposit Insurance Corporation regulates state banks that don't belong to the Fed. The U.S. Treasury's Comptroller of the Currency regulates national banks and the Office of Thrift Supervision oversees savings and loan associations. And that's over and above the rules for credit unions, federal savings banks, and the rest of the nation's tangled financial structure.
It's little wonder that Paulson seeks to simplify a system whose complexity has befuddled consumers and created cracks that high-flying mortgage brokers exploited. Some financiers, including the Business Roundtable, have supported the Paulson blueprint, but many financial industry groups are worried about the proposed dismantling of agencies with which they have long been working.
Some financial companies argue that failures by the states in overseeing mortgage originators helped feed the subprime crisis. Many of these companies, which had long chafed under the burden of dealing with 50 different regulators, quietly applauded Paulson's plan to consolidate regulation -- although they feared making too much noise and worsening the intergovernmental conflict.
The best that Paulson's supporters can hope for is that the next Congress takes up the blueprint, after the mortgage meltdown has congealed. The more likely result, however, is that Galvin and his state colleagues will remain locked with the feds in an ongoing struggle over regulatory power.
In the meantime, the forces that produced the subprime mess are likely to persist even as global financial cross-pressures become more unforgiving. The ongoing battle over who is in charge will produce even more clumsiness as the money industry moves faster than the government's ability to control it.
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