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Regulating the regulators in the US: The conservative proposal of President Obama

This column examines the white paper on financial supervision issued by the Obama administration in mid-June. It focuses on the proposal’s preference for interagency cooperation over supervisory consolidation and warns that such an approach, while politically expedient, risks worse governance outcomes.

In mid-June 2009, President Barack Obama issued a white paper covering a wide swathe of areas of financial regulation that proposed a new architecture for financial supervision. The white paper proposed two new authorities: a National Bank Supervisor and a Consumer Protection Agency. The National Bank Supervisor will supervise all federally chartered banks. The new agency will incorporate two existing authorities: the Office of Thrift Supervision and the Office of the Comptroller of the Currency. The Consumer Financial Protection Agency will protect consumers across the financial sector from unfair and abusive practices.

Furthermore, the government plans to build up a body responsible for macro-prudential supervision. The white paper proposed to establish a Financial Oversight Council to identify systemic risks and improve cooperation among US regulators. Its membership will comprise the US Treasury, the heads of the Federal Reserve, the National Bank Supervisor, the Federal Deposit Insurance Corporation, the Securities and Exchange Commission, the Commodity Futures Trading Commission, the Consumer Protection Agency, and the Federal Housing Finance Agency.

Regarding the central bank, the white paper proposed to increase the powers of the Federal Reserve. The Federal Reserve would be given new responsibilities to supervise all institutions that could represent a threat to financial stability, even those that do not own banks.

The Obama proposal confirms the hybridism of the regime, with many authorities (such as the Federal Reserve or the new Consumer Protection Agency) monitoring more than one segment of the market and others focusing on only one. The proposal does not follow the trend toward supervision consolidation, even though the crisis made evident that the fragmented supervisory setting can be incapable of monitoring the integrated, interconnected, and complex reality of US financial markets (Leijonhufvud 2009). The proposal preferred to promote interagency cooperation instead of agency consolidation. How can we explain the path dependency of the multiple-authorities regime?

First, there are so far no theoretical studies in the economic literature that consider the US policymaker objective function in designing the financial supervision regime. A recent empirical paper (Dalla Pellegrina and Masciandaro 2008) highlighted a possible relationship between multiple-authority regimes and bad governance practices. In terms of the relationship between bad governance and supervision, the study interprets the latter as a possible way of compensating lobbies (vested interests) with power, in a setup where rent-seeking behaviour involves reciprocal string-pulling. Hence, more rent-seeking politicians will seek to create more institutions (or leading positions) in order to please all interests in terms of power and future connivance.

Secondly, if we note that the reform proposal increased the role of the Fed, we will have another example of central bank fragmentation; the degree of consolidation decreases while the central bank’s involvement in supervision increases. The proposal was attacked last month by a coalition of investors, analysts, and ex-regulators who criticised the central role of the Fed in this plan, proposing an alternative institutional option – the establishment of a new Systemic Risk Oversight Regulator, with a full time staff led by a chairman and four members appointed by the President and confirmed by the Senate, accountable to Congress (Financial Times, 2009).


How we can evaluate the Obama administration’s proposal? Before the crisis, regulatory trends seemed characterised by consolidation of supervision and central bank specialisation in pursuing monetary policy. Where several authorities are present, the central bank is likely to be deeply involved in supervision. This phenomenon was labelled the central bank fragmentation effect.

The new proposal seems to follow the same relationship, although in an original shape, by suggesting a setting with multiple authorities with increased central bank involvement using the “new” formula of the macro supervision.

Let us qualify our assessment. First of all, the experience of these past few months has stressed the importance of overseeing systemic risks. In other words, it is crucial to monitor and assess the threats to financial stability arising from macroeconomic developments in the economic and financial system as a whole (macro-prudential supervision). The increasing emphasis on macro supervision motivates policymakers to identify specific bodies responsible for it. Carrying out macro-prudential tasks requires information on the economic and financial system as a whole. The current turmoil has stressed the role of central banks in the prevention, management, and resolution of financial crises. Therefore, it is now clear that central banks are in the best position to collect and analyse this kind of information, given their role of managing monetary policy in normal times and acting as the lender of last resort function in exceptional times.

Therefore, from the policymakers’ point of view, the central bank’s involvement in macro-prudential supervision would create potential benefits in terms of information. At the same time, they can postulate that the potential costs of the involvement are smaller with respect to the case of micro supervision (such as moral hazard risk, conflict of interest risk, powerful bureaucracy risk). In other words, the separation between micro and macro supervision can be used to reduce the arguments against central bank involvement.

It is possible to have consolidation in micro supervision without any reduction of the central bank involvement in macro supervision. But this was not the case. Policymakers chose to maintain supervisory regimes where there are already many authorities. We have already proposed a possible political economy explanation of the conservative behaviour of politicians; notwithstanding the crisis, they considered the expected benefits of reducing fragmentation to be less than the expected gains from political and bureaucratic consensus in maintaining the status quo. At the end of story, we again observe greater central bank involvement in supervision coupled with a multiple-authority regime, confirming the central bank fragmentation effect.


Dalla Pellegrina, Lucia and Donato Masciandaro (2008), “Politicians, central banks, and the shape of financial supervision architectures”, Journal of Financial Regulation and Compliance, Volume 16, Number 4, 2008 , pp. 290-317(28).

Financial Times (2009), “Coalition to attack plan for Fed powers” 15 July.

Leijonhufvud, Alex (2009). “Curbing instability: policy and regulation,” CEPR Policy Insight 36, July.

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