Exactly one year ago, the U.S. government began planning its takeover of AIG to prevent the collapse of the largest insurance company in the world. The public seemed outraged that taxpayers had to save a private company. Congress vowed to rewrite the rules of American finance, to prevent any bailouts in the future.
Now, Democrats and Republicans are set to spend much of the fall battling over that regulatory reform. Getting Republicans and Democrats to agree may be the easy part.
For starters, lawmakers generally agree that the financial system has too many regulators. AIG was watched over by 400 different agencies around the world, including dozens in the U.S., and none of them noticed that the company was on the verge of taking down the entire global economy.
Economists say this kind of problem stems from regulatory arbitrage. When more than one regulator oversees the same kind of activity, financial firms find ways to play one off against the other. It's like what every 4-year-old has figured out — if Mommy won't let you, maybe Daddy will. Or worse, if Mommy thinks Daddy is watching you, and Daddy thinks Mommy is watching you, then you can get away with anything.
The other thing Democrats and Republicans agree on is that solving the problem by simply merging some of the regulators will never happen.
Consider one of the most glaring examples — the bizarre division of labor between the Securities and Exchange Commission, and the Commodity Futures Trading Commission. If you buy and sell stocks, your overseer is the SEC. If you trade stock futures or their kin, you get the CFTC.
Much of the current financial crisis is linked to the strange financial products that fell between the cracks of the SEC and CFTC.
Rep. Barney Frank (D-MA) is steering the reform process as chairman of the House Financial Services Committee. He says the consensus is clear — and so is the outcome. "Obviously, we all know it would be better not to have two separate entities," he says. "It would be better to have just one. It is now and will be politically impossible to put the two together."
In Washington, Never Yield Power
Frank's foregone conclusion rings true for Republican Mike Oxley of Ohio, a former House member and chairman of the Financial Services Committee. During his time in office, Oxley tried to merge the SEC and CFTC after a series of high-profile scandals like the one at Enron. "Barney doesn't want to fight that," Oxley says. "He saw what I went through, and he figures it just isn't worth it. And I think he's probably right."
Oxley says this crazy system of two agencies watching over the same process grew out of the 19th century, when stocks were traded in New York and grain futures were traded in Chicago. The former got regulated by the SEC, the latter by a precursor to the CFTC.
Back then, the futures regulator was part of the Agriculture Department, which futures traders saw as friendly and easy to deal with. They fought every effort to bring in the SEC. In 1974, Congress created the CFTC as an independent agency under the control of the House and Senate agriculture committees.
In the 1980s and 1990s, when Wall Street went nuts creating financial derivatives that had nothing to do with food or other physical commodities, a series of powerful House Agriculture Committee chairmen — supported by the futures traders — made sure to keep these derivatives under their jurisdiction. Congress would have to approve any merger of the SEC and CFTC, and that means either convincing or forcing the chairs of the Agriculture Committee to yield some of their power. And that just never happens.
In Washington, losing power means losing support for re-election and money from special interest groups to help you campaign. You can look at the situation purely cynically and say that if you're the chair of the Agriculture Committee, you don't want to give up big donations from lobbyists.
Or you can look at things sort of cynically. The more affairs a chairman oversees, the bigger budget he or she gets, and the more staff. Power makes it easier to trade favors in exchange for votes that benefit your constituents.
You can even look at the situation with a certain idealism. The more you oversee, the more power you have to make the world a better place.
Worse Than Beating A Dead Horse
Whatever kind of congressperson you are, you want to hold on to your jurisdiction. Given the way Congress works, that means it's almost impossible to end regulatory arbitrage.
Even now, one year after the division of regulators helped cause that huge financial crisis, Oxley says trying to merge those agencies is worse than beating a dead horse.
"That horse is not only dead, but it's been dissected and ground up for horse meat. Give it up," he says. "It's like, I'm never going to beat Tiger Woods. I've come to terms with that issue. ... I'll beat Tiger Woods before the SEC and CFTC are merged."
A year ago, there were at least 106 regulators overseeing large financial institutions in the U.S. Everyone from the president to leading Republicans and Democrats to almost every important economist agrees that's too many. But according to the proposals with the greatest likelihood of passing, the U.S. will likely get rid of exactly one regulator, the Office of Thrift Supervision — bringing the number down to 105.
Lawmakers also plan on creating a new one — the Consumer Financial Protection Agency. If that happens, we'll end up back where we started with 106 regulators, and 106 chances for regulatory arbitrage.