Chris Dodd’s plan to combine federal banking regulators gets pushback from reform-busters

Student blogger Lucas Puente sees benefits to a super-regulator…

Regulatory arbitrage is a dangerous  little Wall Street practice that, if left unchecked, threatens the stability of the economy. How it works: Under the current system, banks can shop around to find the most advantageous charter, which basically allows them to choose what kind of regulatory supervision they will have.  And with their future growth (or shrinkage) more or less tied to the number of banks they regulate, today’s regulators have an unmistakable incentive to provide a permissive regulatory environment that favors the banks. Under this perverse system, it’s simply not in their best interest to crack down on the banks they regulate. Actually, quite the opposite.

Why? Banks will simply switch their federal charter to a more lenient regulator. This was arguably most obvious in the regulatory “strategy” of the Office of Thrift Supervision (OTS), the home of 18 of the banks closed by the FDIC so far in 2008 and 2009.

The Treasury department has proposed measures to address this problem in its white paper. The first idea is to merge the OTS and Office of the Comptroller of the Currency (OCC) into a new National Bank Supervisor. Second, the Treasury called for the proposed National Bank Supervisor, Federal Reserve and the FDIC to enact uniform regulatory fees. Finally, it advocated lowered regulatory fees for community banks in order to encourage them to have a federal charter. Simply by removing 50% of the options banks have regarding federal charters, the first measure would be addressing this issue. The second and third proposal would eliminate arbitrage based off fees — a key initiative as, in addition to choosing their charters off regulatory lenience, banks often chose the “cheapest” regulator, whether that is their state regulator or one of the federal bodies.

Treasury wants to blend two agencies into a bank supervisor, but Chris Dodd wants all four into one. Dodd, chairman of the Senate Banking Committee, proposes merging the four primary federal banking regulators (OTS, OCC, the Federal Reserve and the FDIC) into a super-supervisor, a la the U.K.’s Financial Services Authority. This restructuring would only apply to the regulatory duties of these entities, while the Fed would maintain its current role in conducting monetary policy and the FDIC would continue to operate its depository insurance fund. (Dodd is also behind the Consumer Financial Protection Agency).

Naturally, Dodd’s plan faces stiff resistance from industry leaders, inertia-prone members of Congress, and, of course, current regulators concerned with protecting their home turf. Demonstrating this opposition, Edward L. Yingling, president of the American Bankers Association, remarked that Dodd’s sweeping consolidation plan is based on a model that “hasn’t worked in other countries that have tried it and it faces plenty of opposition in Congress.” Although the U.K. has taken in plenty of hits in the current crisis, even the American Enterprise Institute acknowledges that the FSA has distinct advantages due to its streamlined regulatory structure.

Whether Dodd’s bill is the right answer — or the one that will pass — is up for debate. The key is making sure that regulatory arbitrage doesn’t get left out of whatever new system is put in place. The Beltway seems to be a place of astute amnesia, when it’s politically prudent. Need we say “public option”?