How Low Can You Go? The Market for Regulatory Fees

The close, unholy, and corrupt relationship between Wall Street and Capitol Hill isn’t really news any more. And so inured have our sensibilities become to the giant, rigged con-game that is today’s financial-political system, that exposure to yet another one of its details fails to induce any suitably condemnatory reaction. Still, that said, when a babe-in-the-financial-woods like me turns his attention to trying to understand the grim forensic details of how this nation, despite suffering one  financial calamity after another, is still in the hock politically and economically to its architects, he is liable to stumble onto revelations that have not lost their capacity to shock and awe. (I’m well aware that the details below are unlikely to be news for veterans of this arena.)

Consider then, the market for regulatory fees. (I owe my edification in this matter to Simon Johnson and James Kwak‘s excellent 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown.) A quick primer: while Congressional legislation ostensibly constrains the activities of financial institutions,  actual, on-the-ground regulation is carried out by components of the executive branch–the Treasury Department, the Federal Reserve–and a smorgasbord of agencies (including, for our current interests, the Office of the Comptroller of the Currency (OCC) and the Office of Thrift Supervision (OTS); on July 21, 2011, the OTS became part of the Office of the Comptroller of the Currency).

These two agencies, among others, were “funded by fees levied solely on the banks they regulate.” And financial institutions that fell under multiple regulatory agencies were “allowed to select their primary regulator.” Let’s take a short break so that you can ruminate on the various possible outcomes of a setup like this.

Done? Good.  How would such a market function? Presumably, agencies would compete–in order to ensure their financial viability–for the attention and patronage of those they sought to regulate. And those that were to be regulated would stroll through the boutique of agency offerings, inspecting fee schedules and regulatory requirements, turning up their nose at an ‘expensive’ offering of a seemingly-onerous regulation. Agencies would jostle for position, begging financial institutions to accept their regulations, perhaps by lowering fees, and far more interestingly, by tweaking and weakening their regulations. A suitably enervated set of regulations, coupled with a modest fee schedule, would stand out  as a prominent offering in this bustling bazaar of foxes-in-the-coop. (If there is one thing I’ve learned from market logicians, it is that I can predict outcomes like this with some confidence; market analysis does work, huzzah!).

Even among this lot of lily-livered law enforcers the OTS distinguished itself by its pusillanimity. Unsurprisingly, American International Group (AIG; remember them?) chose the OTS as its primary regulator when it opened a savings and loan, despite the fact that OTS with its primary focus on mortages was patently ill-equipped to take on the task of regulating the bankrupt offerings of AIG’s Financial Products Division. And in 2005, the mortage lender Countrywide, irked and chafing at the bit at its regulation by OCC, decided to switch to the more friendly OTS.

Cliche time: the rest is history.

Market Panglossianism; the curse of our times.

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