Lawrence A. Cunningham & David Zaring · November 2009
78 GEO. WASH. L. REV. 39 (2009)
First the financial markets collapsed, and second came massive government intervention designed to address the collapse. The third part of any financial crisis is reform. Judging by the exuberant production of scores of ambitious alternative visions for financial regulation reform, one might be forgiven for expecting unprecedented reform in the aftermath of the 2008 crisis. In considering what reform should look like, we caution that the headlong rush to do something should not neglect the surprisingly good things about the old system or ignore the considerable reform that has already been achieved by the federal government’s massive and unorthodox response to the recent financial crisis. Moreover, our note of caution may be practical, as well as good policy; we note that it is reflected by the Obama administration’s first formal proposal for regulatory reform to Congress.
Among the bewildering proliferation of alternatives, one, offered by Treasury Secretary Henry Paulson shortly after the failure of the first of many institutions in March 2008, boldly imagined a revolution in financial regulation, largely through a comprehensive reorganization of governing agencies. After it, other recommendations poured in, each with their own revolutionary visions of financial regulation reform, including two by an organization of financial industry notables led by Paul Volcker, the Group of Thirty. Other grand visions come from the Government Accountability Office (“GAO”), the Consumer Federation of America, the Congressional Oversight Panel created to oversee government interventions, plus a flurry of reports by Washington think tanks, dis- or semi-interested observers, and blue ribbon panels.
Which of these regulatory alternatives, then, should be preferred? As scrutiny of the system of financial regulation reaches a new apogee, should we embrace the greener grass of organized reform, or stick with one of the (arguably) two systems we currently have? If opting for planned centralization, is Paulson’s or Volcker’s grand vision to be preferred?
This Article delineates these alternative approaches to financial regulation and provides a framework to assess them. Some issues turn on questions well beyond law, including economic theory, political science, and international relations. Moreover, the alternatives confront a vast swath of the U.S. regulatory bureaucracy, essentially all aspects of its financial markets and dozens of large regulatory organizations; the approaches have considerable effects on the real economy and present literally hundreds of discrete, and important, issues for decision. These complexities, and the prospect of both many proposals and potential revolutionary change, suggest the usefulness of having a framework for evaluation, which this Article provides.
Our most important normative conclusions are worth emphasizing at the outset. First, as we have suggested, the pre-2008 crisis fragmented approach is a model in its own right, with characteristic benefits, although undoubtedly accompanied by flaws. Although debate about regulatory reform may incline to elide these benefits, they have a considerable academic pedigree that must be appreciated.
Second, there has already been considerable financial regulation reform amid the government’s responses to the 2008 crisis. It is not as obvious as many appear to believe that additional, and certainly not revolutionary, formal steps are appropriate. If anything, it might be helpful to ratify the useful reformations to the system worked by the on-the-fly regulatory response and eliminate or reverse less desirable ones.
Third, although the approaches exemplified by the Paulson and Volcker proposals both prescribe centralization to abandon fragmentation, they do so using different models, for different reasons, and with different objectives—both federalize and centralize, but then one delegates to industry self-regulation in the name of promoting U.S. global competitiveness whereas the other proposes to regulate, as apolitically as possible, and collaborate with international counterparts.
Fourth, we think the practicalities of international regulatory reform may require some caution there as well, although the international implications of this reform are not the focus of this Article. We nonetheless think it is prudent for the chief regulatory reforms to depend on a vision of globalization. We also believe an approach that embraces the fact that both finance and regulators can cross borders is more sustainable than one failing to embrace those realities. Grand visionaries of regulatory reform may not be thinking through the practicalities and, increasingly, the necessity of regulatory cooperation; that cooperation has worked in the past through ad hoc regulatory response, and we think that abandoning effective ad hoc networks could be perilous. This does not mean that current domestic reform efforts in the United States should determine exactly how, and how much, international financial regulation should be coordinated. Reasonable minds may differ on that issue—indeed, we may not agree on the right institutions for international cooperation.
Finally, we observe that our cautions appear to be reflected in one particular implementation of these visions. On June 17, 2009, the Obama administration announced its vision for financial regulation reform. Captured in a document entitled “A New Foundation: Rebuilding Financial Supervision and Regulation,” the proposal gives the Fed and the executive branch of government more power over financial markets. But it does not centralize oversight in the way that either the Volcker or Paulson proposals suggest; instead, it appears to embrace some of values of the old, disaggregated regime. In the Obama proposal, the government adds to the Fed’s systemic stability powers—giving it, for example, the power to oversee more non-banks, should they threaten stability, and all institutions holding bank charters, who would otherwise be overseen, on a consolidated basis by a new National Bank Supervisor office in the Treasury Department. Regulatory coordination would not be done by a new agency, but by a new Financial Services Oversight Council, which would be created to replace the President’s Working Group on Financial Markets (“PWG”). The proposal also includes a new consumer protection agency to oversee mortgages, credit cards, and other financial devices used by ordinary individuals.
The rest of this Article proceeds as follows. Part I examines the prevailing models, introducing first the traditional fragmented regulatory structure and illustrating its relatively familiar method of responding to periodic crises on an ad hoc basis. It then studies federal actions amid the 2008 crisis, which amounted both to ad hoc crisis response in the American tradition, as well as its own model of regulatory reform. We also consider unusual aspects of the tools used in the 2008 crisis, highlighting its response-by-mega-deal, and exploring the oddity and utility of Treasury’s pre-crisis blueprint.
Part II examines the Treasury’s blueprint and the Volcker proposals and illustrates their shared penchant for centralization of financial regulation. Examination reveals the subtle but important differences in their motivations, the blueprint seeing globalization as a challenge to meet with regulatory competition and the Volcker proposals seeing globalization as a solution to regulatory limitations worldwide, manifested in the 2008 crisis. Paulson seeks centralization in order to promote U.S. capital-market competiveness, projecting the U.S. into a regulatory competition with other systems. Volcker seeks centralization within the U.S., and coordination among other nations, to promote order in global financial markets.
Part III considers these three or four approaches to financial regulation, and relates them to the literature on administrative law and regulatory theory. It discerns procedural and philosophical objectives of the Paulson and Volcker visions, the former vesting newly consolidated federal power in the executive for deregulatory and competitive ends, the latter in independent administrative agencies for re-regulatory and control-oriented ends.
Ultimately, neither grand vision may be sustainable. We may yet be left with remnants of the traditional U.S. fragmented system, as concentrated by the on-the-fly reforms made during the 2008 crisis, with perhaps new regulations addressing certain financial instruments and institutions previously outside federal regulatory purview. We evaluate the merits of this incremental approach as well, leading to our conclusion that incremental regulatory adjustments rather than sweeping regulatory revolution are both superior and more practicable. Indeed, in our view, the proposals that the Obama Administration first presented to Congress reflect an understanding of these values, and we have found their incrementalism to be appropriate and broadly consistent with the analysis of options presented here.
