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A Pragmatic Approach to the Phased Consolidation of Financial Regulation in the United States

By Harvard Law School Program on Corporate Governance

I recently issued a paper entitled A Pragmatic Approach to the Phased Consolidation of Financial Regulation in the United States, which recommends an approach to reforming the US system of financial regulation. The proposal comes against the backdrop of dramatic increases in market volatility, unprecedented interventions by the Federal Reserve Board to sustain securities firms, palpable failures to protect consumers in mortgage lending markets, and lingering concerns over the competitiveness of the American financial services industry, which have all combined to put regulatory reorganization — and related issues of regulatory consolidation — on the national agenda.

One recurring theme in recent events has been short-term initiatives to expand the role of the Federal Reserve Board for issues related to market stability. In some cases, such as the creation of the new credit and liquidity facilities of the past few months, the Board itself has expanded its supervisory reach under existing statutory powers. In other cases, such as the recent memorandum of understanding between the Federal Reserve Board and the SEC, the expansion has been effected through improved information sharing agreements with other regulatory bodies. And, in yet other cases, such as recent legislative proposals coming in congressional testimony from Treasury Secretary Paulson and Federal Reserve Board Chairman Bernanke, the expansion of Federal Reserve authority would necessitate legislative action. To a considerable degree, these initiatives are consistent with the long-term vision for an optimal system of regulatory reform articulated by the Treasury Department in its Blueprint for a Modernized Financial Regulatory Structure in March.

What has not yet received attention is whether other aspects of the Blueprint ?s proposals for consolidation should be implemented and, if so, how those other aspects relate to the on-going expansion of Federal Reserve Board authority and its role in ensuring market stability. My paper addresses those issues. Drawing on lessons learned from the experiences in other jurisdictions, the paper explains why consolidated oversight as implemented in leading jurisdictions around the world offers a demonstrably superior model of supervision for the modern financial services industry. It also discusses the different ways in which financial supervisory systems can be consolidated and how the process of consolidation can be staged. It recommends the establishment of an independent umbrella organization — the US Financial Services Authority — and that reorganization be staged in a series of phased steps whereby the most important coordinating and oversight functions are first consolidated under this organization and the supervisory components of the industry integrated at a later date.

This recommended path to consolidated supervision has many advantages over the approach proposed in the Treasury Blueprint. A key one is that the coordination of market conduct and prudential functions is handled within a single regulatory body, free from inter-agency disputes or potential litigation. With appropriate safeguards, the regulatory body, as an independent agency, may be protected from excessive political interference and more likely to attract and retain high-quality staff, particularly in senior positions. The recommended approach is also fully consistent with the establishment of the Federal Reserve Board as the agency responsible for ensuring market stability across the financial services industry.

The paper elaborates upon this approach to reforming our system of financial regulation. Many aspects of the program would entail federal regulation. Without proposing specific statutory language, the paper outlines the key issues that would need to be addressed, emphasizing areas in which the new consolidated regulatory agency should be delegated authority to develop appropriate administrative structures and resolve jurisdictional disputes. The paper is available here.

Full post as published by The Harvard Law School Corporate Governance Blog on November 18, 2008 (boomark / email).