Financial Regulator-in-Chief?

Recent announcements by U.S. Treasury Secretary Timothy Geithner and the release of suggested legislation addressing the process to be followed when the Federal Deposit Insurance Corporation is asked to resolve a troubled and systemically important non-bank “financial company” have begun to fill-in some very important blanks on a very important job description.

The role of the “systemic regulator,” beyond participating in the thumbs-up, thumbs-down decision as to whether the troubled institution is declared insolvent and sent on to the FDIC as its conservator or receiver, remains a work-in-progress.

There is a very practical reason advanced for the proposed installation of this regulator-in-chief – Congress, the media and at this point probably 90% of anyone asked on the street – want someone to ensure that a crisis like the one we’re weathering never occurs again. Just as importantly, there is a political rationale – they want someone to blame if it does.

With those two thoughts in mind, just how does a regulator (who most likely will already have a day job regulating some critically important aspect of the banking industry) position itself to know enough about a systemically important company that it can make the call that it’s danger of failing? Or is the point to have that regulator act more as a “back up” or shadow regulator to prod the principal regulator (if there is one) into righting the ship before the situation is dire, a role previously envisioned for the Federal Deposit Insurance Corporation after the savings and loan crisis of the 1980s?

The Federal Reserve, the agency presently at the top of the leaderboard in the “Regulator-in-Chief” tournament, regulates bank holding companies in a variety of ways. First, it holds the keys to the car. The Fed must approve a company’s qualifications to own or even control a bank. Secondly, the Fed must be given notice by the bank holding company of any new nonbanking activities or acquisitions. The Fed must be given periodic financial information by the company, and has the ability to require any other reports at any time, and may examine the company at any time. The Fed prescribes capital requirements for bank holding companies, and has extensive enforcement authority over such companies. The Fed can force a bank holding company to divest itself of subsidiaries or to terminate its activities if those subsidiaries or activities pose a serious risk to the financial safety, soundness, or stability of the affiliated bank.

In other words, the Federal Reserve has many tools at its disposal to regulate and supervise these companies from cradle to grave. How broad will the daily authority of the Federal Reserve (or whatever other agency is charged with the systemic risk responsibility) be to regulate and supervise these non-bank entities? What level of consultation with the institution’s functional regulator will be required? When will the systemic regulator be empowered to step in and say “enough is enough?”

If you were in charge of the agency tasked with ensuring that an AIG-type disaster never again occurred and knew that your agency would be chopped, sliced and diced by everyone from Congress to Joe the Plumber if you failed, how extensive a set of powers would you want?