Simplify, Simplify

Story Highlights:

• Fragmented US financial regulation worsened the recent crisis—a quick glance at all the agencies directing traffic confirms its unnecessary complexity.
• History shows the system grew ad-hoc as new institutions were superimposed on the existing structure without replacing it.
• The UK, Japan, and Germany have unified regulatory bodies—it's time we follow suit.

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With the holidays upon us, we all likely remember the mayhem that would ensue at the "kids" table once the participants were freed from the shackles of the rational adults.

Our hodgepodge financial regulatory system and the unpredictable way it shares power isn't so different. Though our tangled regulatory system itself received scant media attention throughout the recent financial crisis, we think its inconsistent, seemingly rudderless approach to government-sponsored mergers, nationalizations, and bankruptcies vastly increased uncertainty and made a bad situation much, much worse. The problem? Too many cooks in the kitchen.

To see the complexity, one need only review the laundry list of agencies directing traffic. Most familiar are the Federal Reserve, the Treasury, and the Federal Deposit Insurance Corporation (FDIC). Even Congress was given sway over financial regulation (e.g. congressional requirements limiting executive pay attached to TARP funds). Beyond the familiar there are myriad other regulators too, with criss-crossing jurisdiction and conflicting mandates. Banks answer to the Securities and Exchange Commission (SEC), the National Credit Union Administration (NCUA), the Office of the Comptroller of the Currency (OCC), as well as individual state insurance and bank regulators. Some investments are overseen by the Securities and Exchange Commission (SEC), but others by the Commodities Futures Trading Commission (CFTC).

How'd we get so muddled? State and federal banks arose in the early 19th century largely unregulated. After state-chartered banks contributed to the Panic of 1837, state-level regulations were set up with minimal coordination state-by-state. The National Bank Act of 1863 gave rise to federally chartered banks and the OCC to monitor them. Later, to address rampant financial instability and help ensure the smooth functioning of markets—a worthy goal, to be sure—the Federal Reserve System emerged in 1913, the FDIC in 1933, and the SEC in 1934. Yet as Milton Friedman described the evolving system: "In typical governmental fashion, the new distinction did not replace the old; it was superimposed upon it."

During healthier times, regulatory disorder contributes to business inefficiencies—it takes a crack team of highly paid lawyers just to stay current, and even more effort to shift resources as required. But in times of crisis, a fragmented system with its uncoordinated demands and strictures can significantly worsen an already delicate situation—this fall's chaos, case in point.

The remedy to this chaos and confusion? A unified voice and set of rules would be ideal. Some other developed nations have already gone there. The UK was the first to unify its regulatory bodies, followed by Germany and Japan. Aware there's room for improvement, the Treasury's shown interest in regulatory revamping. But there's no serious talk yet of consolidation, and it remains to be seen whether the coming regulatory reforms will make things simpler or more confusing—call us jaded, but our money's on the latter.

We've made it this far as a financial superpower in spite of our regulatory system. Maybe it's time to quit the habit of superimposing one regulatory body on another and as Thoreau once said, "Simplify, simplify."