Jeebus. This sure sounds like a free market tinkle-down nightmare to me. Let me get this straight.

USGov sets up a regulatory agency, funded by those it regulates. Don't like the regs, Mr CEO, then shop for a different agency and pay them to do their job - just not too well, eh?. WTF?

This must be a high point (or low, depending) for Republicanite governing. Everything, including financial regulation & security, is always for sale to the highest bidder.

Built-in corruption is the name of their game.

I would say that I'm astonished but nothing these rat bastards does surprises me anymore.

Hang 'em.

All lending institutions are in business to make money, as much of it and as quickly as possible, and to achieve commanding market share. Overregulation and too much state control results in something like the banking model of the former Soviet Union (which, by the bye, doesn't protect you from going bust: my in-laws lost everything they had in their local bank in the Russian Far East, and now have a pervasive mistrust of banks), while the beloved-of-Republicans "laissez-faire" model can (and did) result in the meltdown which currently prevails.

Consequently, a fine line must be walked which encourages competitive business, but keeps an eye on how the deals are done.

One constant in financial crises seems to be banks that get so big and powerful that they become an act of God, and think they are immortal. The bailout is going to leave that state of affairs in place. Recent articles have pointed out that many smaller neighbourhood banks are doing just fine. The bailout plays directly to consumer confidence, which I'll allow is vital, but it will still concentrate too much power in too few hands. There's no such thing as a contrite banker, and they will soon forget their ad hoc solidarity when things improve - as they must.

I can't believe it. I can't believe we didn't learn anything over the last 25 years.

A little history.

I worked at the FDIC in the 80s. I remember seeing Savings Banks being forced to raise capital and change there business practices when the S&L accross the street didn't have to do either. The Savings Bank I was examining was eventually forced to merge with a bank but the existing shareholders received shares in the new bank. The Savings and Loan accross the street cost the government millions of dollars.

Why? Because the FDIC did its job and the S&L regulators were more interested in protecting theirs. If all the S&Ls and Savings Banks failed then the FDIC would still exist but the FSLIC and the FHLBB would be out of jobs.

The S&L crisis is almost completely due to the lack of regulation from the old FSLIC and the FHLBB. Those entities were in charge of regulating S&L's in the 80s. The FDIC regulated Savings Banks in the 80's.

What is the main, and maybe the only differernce between an S&L and a SB in the 80's? Answer: the regulator.

Why do you think it was an S&L crisis and not a Savings Bank crisis? Answer: The FDIC did its job and closed Savings Banks before the losses got to big. FSLIC tried to handle the crisis by merging dead S&L's together and pretended they had extra capital. Then the big S&L continued to lose money and continued to take risks and the failure was 10 times bigger because the regulators let them continue to lose money after they were already dead.

Honestly, my guess is that 50% to 80% of the S&L crisis was caused by the regulators.

My guess this time is that the OTS, the new name of FSLIC, isn't to blame for too much of the problem.

I wonder if we ever will figure out the problem this time. Part of it is that people were paid extra bonuses for understating risk. It appears to have been a significant part of the problem with CDS at AIG. It appears to have been a significant part of the problem at Merrill Lynch and CitiGroup.

Bravo for finally hitting on this.

In many ways, the United States regulatory regime resembles less any other proper developed country, than some bizarre Latin American backwater. Youv'e gotten away with this irrational, in fact utterly insane complexity in regulatory structure out of sheer wealth.

Contra what I am sure will be the howling of the hard Leftist gits who normally post here, the irrational structure seems to be a result of your federalism taken to an extreme, plus the natural desire of bureaucrats to keep control of their feifdoms, and thus fight tooth and nail any rationalisation of the bureaucracy.

This is hardly corruption as the first commentator idiotically asserted. Corruption means acts against the law, bribe taking. Rather it is much more insidious, it is simply human organisational behaviour's tendency to empire and fief building, without any proper counter weight.

Fee financed regulation has some things going for it, but can easily go rather wrong without good structures, and can easily drive perverse incentives. Levying a common fee would not be very intelligent as the needs for the various kinds of oversight are different. However, without an umpire to prevent mere fee shopping - rather than actual business and structure driven oversight, then you get ever worse behaviour.

There is a need for specialisation in regulation between types of financial entities, but that does not mean that there has to be an insane proliferation of entities that virtually beg for confusion and perversely incentivise firms to opt for sub-optimal structures.

The US should follow international best practise and either organise a universal financial regulator with specialised divisions, or follow the alternative best practise model and have only three regulators with sub specialists: Banking, Capital Markets and Insurance. Most proper countries do either one or the other.

One could achieve massive improvements in regulatory efficiency and rationalisation, to the gain of the public AND the financial sector by undertaking this simplification and unification.

Also bravo to Neil Wilson for those comments.

Unfortunately extreme balkanisation of authority in government always produces these kinds of failures. A bit of competition may be okay, but not balkanisation.

Beyond the unification of the federal regulators you should also look to the balkanisation at the 'states' level, it is absurd that there are national and international entities that are regulated by what are in effect provincial regulators.

One need not ramble on about Enron or Corruption, that is to entirely misunderstand the problem, although sadly the reflex of the populists.

One need not ramble on about Enron or Corruption, that is to entirely misunderstand the problem, although sadly the reflex of the populists.

It is not to entirely misunderstand the problem, it is to entirely misunderstand the cause, or viable solutions.

A balkanized organizational structure, whether public or private, not only is less efficient, but it also is more prone to succumb to the very damaging effects of corruption. This is primarily because corruption can take hold in one part of the system and thrive without being detected. Then it is only a matter of time before it spreads to neighboring parts of the system. Before you know it, the whole damned thing is rotten.

Corruption makes a bad problem even worse. You may argue that corruption is inevitable wear humans and money are concerned, and, I would agree, but the damage can be contained if there are mechanisms in place to detect it when it occurs.

In a labarynthine regulatory structure, there are just too many places to hide.

Sometimes less really is more.

We don't necessarily need more regulation, we need smarter regulation.

If this administration is to fulfill the expectations placed upon it, and if the American economy is to drag itself out of the shallow grave in which it lies partially interred, it will be a group effort achieved with all shoulders to the wheel. A very bad place to start would be with the marginalisation of others' ideas, and sneering dismissal of the "leftist gits" and "the populists".

Besides, where did you get the idea that corruption is restricted to acts against the law and bribe-taking? How about when the government makes the law and sets the policy? If it works out to benefit the government and its cronies to the detriment of the general population, is that corruption? No? You're in good company with Manuel Noriega and the Saudi Royal Family there.

The free exchange and examination of ideas is how people learn, and learning prevents future catastrophes. People learn nothing when you mock their ideas and imply they're idiots. Stupid is as stupid does.

"giving banks what they want is not what regulators ought to be doing"

On the contrary, wouldn't you agree that was pretty much the mission statement the Bush administration GAVE regulators? Look at who they appointed to head these agencies.

Another awesome post hilzoy though I wouldn't have wasted it on a sleepy sunday afternoon.

I have to say this really blows my mind. I never had any idea that the financial industry was regulated this way. Nor that one agency was responsible for overseeing so many of the firms that went under.

Why hasn't this been a bigger story?

LobbyGov: Very fair points, my intended meaning was that I do not see any reason to suspect regulatory fraud, and leaving aside the legitimate issue of mortgage origination fraud, corruptionand illegal acts are not the real problem (in fact it would make things easier if it were). I understand the insane American practice of having unregulated, non professional 0ortgage brokers' pushing on bad dossiers was particularly the case in no regulation states, but however easy to understand, I do not think this is the explanation of the crisis. Rather (i) risk assumptions and models were broken (which is rather scarier than corruption, and makes Bale II scary), and (ii) the issues related to regulation failure are also not corruption but the complexity as you cited. Yes that allows corrupt practises, but also sloppiness. I rather agree with your observations re this being inefficient whether private or public, the invidious problem that poses is if the howling outrage is focused on 'Enron' type corruption, rather than the subtler evils of a fundamentally honest regulatory bureaucracy that is 'corrupted' by the subtle effects of organisational turf wars, and those without any coherent referee.

I should add that while my blog is now boring, one can to look to my archives when I was actively involved with investments in Iraq, and dealing with the real incompetence and corruption of your outgoing administration. They are a filthy bunch of fools, and Iraq is a failure much due to that. However, this is a different, and harder problem.

Good post, good points.

We need fewer regulatory agencies but with more teeth. We need a small transaction tax on sales of stocks and bonds (.05% or something like that) to fund a beefed up SEC, and reinstate the uptick rule and enforce a ban on naked short selling. Then we need one set of regulators for depositary institutions. We also need to outlaw derivatives in which there is no real underlying collateral--the "hypothetical" kinds of CDOs.

The cause of the problem is partly greed and also partly the idea that a man's worth is measured by the size of his compensation package. This provided incentives all the way down the line to take on too much risk and leverage. The main reason to reinstate high personal tax rates (and maybe even lowwer coprpoirate rates) is to provide an incentive for corporations to retain earnings and use them for strategic purposes rather than pay them all over to the top management for their personal consumption. The former is much more socially useful.

As a retired banking Audit Department Manager, I have to agree completely with the estimate of the OTS. The bank I retired from was under the FDIC regulators but switched to the OTS to facilitate a stock deal. The OTS knew the bank was solid and well capitalize, but cripes they are weak weak regulator. The FDIC were relentless.

We need fewer regulatory agencies but with more teeth.

Yes!

Hilzoy,
I had no idea it was this bad.

With a setup like that, no one could have foreseen the consequences!

"We need to regulate institutions for what they do, not what they are."

We need to regulate institutions for what they are, not what they are called. What they do is what they are.

Time to post my favorite photo of the former head of the OTC "Chainsaw" Gilleran

http://img.photobucket.com/albums/v296/rjw88/chainsaw.jpg

I'm pretty sure OTS also regulated AIG Financial Products, the division of AIG responsible for the company's enormous losses on credit default swaps.

That would be difficult for them, as it was based in London and using a French banking license.