Banking Law

Reporter Heather Landry, in a recent American Banker article that the paper has decided to post "outside the wall," made me laugh out loud with her opening description of a Senate hearing from early last year in which a regulator did the unthinkable: he accepted responsibility.

A Senate hearing in March 2009 about the debacle at American International Group Inc. dispelled two oft-repeated myths.

The first was that AIG's notorious derivatives operation had fallen between the regulatory cracks. An hour and 17 minutes into the testimony, the acting director of the Office of Thrift Supervision, Scott Polakoff, offered up that it was his agency, as the consolidated company's regulator, that was responsible for the financial products unit.

In doing so, he knocked down the second, arguably more pervasive myth: that no one in Washington would ever willingly accept accountability for anything. There followed a brief but unmistakable halt in the proceedings as the senators made sense of what they had just heard.

"It was a wonderful moment," said Lawrence Baxter, a Duke University law professor who studies bank regulation. "Our system is so broken up in terms of accountability that when someone finally accepted some, it was like the dog that caught the cat: now what do we do?"

Encourage more of it ? that would be the obvious answer.

In this case, the dog ate the cat. The soon-to-be-enacted Dodd-Frank opus popularly known as "Financial Reform" will put a bullet in the head of the OTS. While there will be little wailing an gnashing of teeth in the land over that specific result, Landry correctly observes that "the financial reform legislation does little to ensure accountability among regulators."

No amount of law can "ensure accountability" by human beings whose careers depend on never making a move that will cost them anything. A federal regulator makes it to retirement by not making mistakes (or, at least, none that can't be pinned on someone else), not by stepping up to the plate an taking a high hard one off the cheekbone because "that's the right thing to do." After all, as even the late, not-so-straight Eliot Mess realized, the banking regulators had all the tools they needed in the past decade to prevent the subprime craziness that occurred and they not only didn't use them, they occasionally fought those who tried to rein in the crazies. At least, that's the story that guys like Eliot are telling (and so are some ex-bank regulators if anyone's interested in talking to any of them).

"With the benefit of hindsight, it is clear that the Fed and other regulators, both here and abroad, did not sufficiently understand some of the critical vulnerabilities in the financial system, including the consequences of inappropriate incentives, and the opacity and the large number of self-amplifying mechanisms that were embedded within the system," Bill Dudley, the president of the Federal Reserve Bank of New York, said in a December speech. At the time, it was as strong a mea culpa as anyone had heard from the institution charged with supervising the money-center banks headquartered in New York.

Of course, Dodd-Frank muddies the responsibility waters by giving backup authority to examine bank holding companies to the bank's primary federal regulator. As Landry points out, "instead of nobody being held accountable for missing red flags, everybody could be." And that's the way (uh-huh, uh-huh) they like it.

It's a thoughtful article, raises good points in an intelligent way, and is worth a read. Nevertheless, those of us who've been doing this for over 35 years understand that while structural changes in the supervisory environment might incrementally tweak the ability of regulators to prevent the last war, there's little they'll be able to do to prevent the next one, which almost always results from amoral and/or "character challenged" human beings figuring out how to drive Mack trucks through tiny loopholes that many of the rest of us never realized were there. If the best and the brightest among us were manning the watch towers and looking for smoke on the horizon, and those watchers had the integrity to act forcefully when to do so might cause people in a position to do them harm (like...oh...Barney Frank, for instance) to, in fact, do them harm, we might have a chance of heading off the next debacle. Of course, that would require a change in human nature, which not even the federal government of this great land I like to call "America" has managed to muster, notwithstanding decades of social engineering efforts.

The 2315 pages of new federal banking legislation, and the bazillions of pages of regulations that will follow its enactment, will accomplish one thing for which ever red-blooded American subject citizen should be grateful: they will provide employment for reams of bank lawyers for some time to come.