A Look at Treasury's Office of Thrift Supervision

Fallout from the financial crisis has greatly amplified the importance of credit market regulation. The importance rises to the level of that of managing monetary policy. With plans in the works to broaden the scope of regulation to include mortgage brokers, non-bank lenders, hedge funds, and credit derivatives markets, Congress and the new administration should patch the holes in the regulatory umbrella before extending it further; lest we all get soaked again. The holes include having the financial institutions funding the regulators, having too many poorly coordinated regulatory agencies, and having short term political appointees overseeing regulation.
First, the regulatees shouldn't be bankrolling the regulators. The way it works (or fails) now is the bigger the financial institution (banks) the more money the regulators get. Washington Mutual paid its regulator (The Office of Thrift Supervision, OTS) $7.8 million in 2001. As Wamu grew during the housing bubble so did the money it paid the OTS. In 2008 Wamu was paying the regulator close to $23 million a year, accounting for 13 percent of agency's budget. The regulators, along with home owners, speculators, and the banks, was cashing-in on the bubble. With an agency essentially on the payroll of the banks it's supposed to supervise, the independence of the regulator is jeopardized. At a minimum we have the appearance of a conflict of interest that undermines the regulators credibility.
Secondly, there's poor coordination among the numerous regulatory agencies. With five federal banking agencies, each operating independently; it takes forever for the agencies to agree on anything. Uniform action often shows up too late to do any good. It wasn't until October 2006 that the banking agencies agreed on the implementation of the Non-Traditional Mortgage Guidance that was aimed at curbing the irresponsible lending that was wide-spread between 2002 and 2006. By October 2006 the housing bubble had hit stratospheric heights. The clock had already stuck twelve and everything was turning into mush. It was too late.
Additionally, with multiple agencies doing similar work, banks can play regulators against each other. If a large bank doesn't like its regulator, it can pack its bags, change charters, and move to another agency. A bank can throw its weight around and leverage budgetary influence on the regulators to limit the amount of supervision. The mere prospect of a big bank switching agencies can put the regulators on ice. The combination of the banks bankrolling regulators, along with a credible threat to switch agencies, undercuts regulatory authority.
Lastly, politics should be eliminated from the process as much as possible. Leaders of the banking agencies should be appointed in similar fashion as is done with The Fed. Agency leaders should serve longer terms and be subject to less political influence than is presently the case. If the enforcement of regulation has negative short term economic impacts, reflecting poorly on a sitting administration; the channels to pressure the regulators are wide open. Why rock the boat if you're likely to get thrown overboard? The specter of political push-back against regulators has a chilling effect. Additionally, the frequent turnover of short term political appointees places undue focus on short term measures vs. the long term health of the financial services industries. Short term political appointees shouldn't be running the show.
As things stand now, all the incentives are aligned for weak regulation. The banks have paid the regulators handsomely, the regulators are poorly coordinated and divided, and the prospect of political push-back along with frequent changes in leadership has served to keep the regulators on their heels.
There are many lessons to be learned from the current crisis and the landmark failures that have accompanied it. Congress and the new administration should take a close, critical look at the failures and structural problems in the system before extending the system to new markets and institutions. The call for more regulation may be appropriate. It just shouldn't be more of the same.

Edward Cole
e-mail: edwardc.cole@gmail.com