The Department of the Treasury is undertaking a review of our financial regulatory system to assess how well it conforms to a set of seven core principles set forth in a February executive order. As with any system that has been built by many legislative and regulatory hands over many years, there is a lot of room for improvement. A reformed financial regulatory framework would better serve the needs of consumers, investors and Main Street companies.
Let's take a look at each of these seven principles and what kinds of changes they might produce:
The first of the new administration's core principles focuses on the ability of Americans to make their own informed financial choices. Regulators, while typically well-intentioned, often believe the public is unable to make good financial decisions and attempt to do it for them.
For example, the Department of Labor, through a labyrinthine set of rules and exceptions known as the fiduciary rule, is driving financial firms to remove options for retirement investors. The rule is rooted in the belief that investors cannot choose for themselves. Firms have spent the last year determining how they will comply with the rule. One major firm recently announced that it will no longer offer Vanguard mutual funds to its investors. Other firms have shifted customers from commissions to asset-based fees, regardless of which payment option the customer prefers. Asset-based fees work well for some investors, but not for all of them.
Instead, the Securities and Exchange Commission should be allowed to take the lead in any rulemaking related to investors' interactions with financial professionals. Its approach to regulation preserves investor choice: Ensure that investors get the information they need to decide for themselves which products and services work for them.
The second core principle is to avoid taxpayer-funded bailouts. Dodd-Frank moved many types of derivatives into central clearinghouses, which means that clearinghouses will have overlapping, deep ties with every large financial institution. The markets expect that the government, in requiring firms to use clearinghouses, also stands ready to bail them out. Dodd-Frank seems to share this expectation, because it gives big clearinghouses special privileges at the Federal Reserve. Rethinking the clearing mandate is therefore necessary if a repeat of the last round of bailouts is to be avoided.
The third core principle holds that regulation should be rooted in solid economic analysis. Regulators need to be asking basic questions: What problem are we trying to solve? What are the different possible solutions? How do the costs and benefits of these different options compare? Financial regulators, who are notoriously reluctant to ask these basic questions, could do their jobs better if Congress directed them to use economic analysis as they write rules.
The fourth principle states that U.S. companies should be able to compete with foreign companies. Working with foreign regulators to ensure mutual recognition of one another's regimes would further this principle by eliminating duplicative regulation. But domestic regulatory redundancy is also a problem for American firms.
Large financial institutions have many regulators looking over their shoulders and often giving conflicting instructions. Firms spend a lot of time and resources responding to all of these regulators, but consumers, investors and the financial system aren't any better off than they would be if one regulator had sole responsibility for a particular firm. Meanwhile, new fintech companies often have to meet the requirements of multiple state regulators and the Bureau of Consumer Financial Protection. Potential solutions include creating a single bank regulator and allowing fintech firms to operate nationwide under a single state or federal charter.
Core principle five seeks to ensure that U.S. interests are properly represented at international meetings of regulators. International cooperation is important, but regulatory decisions made abroad must not be implemented in the United States without domestic consideration.
One area in which international determinations have shaped domestic regulatory action is in the designation of systemically important financial institutions. International regulators – by designating firms as globally important – are effectively making the decision about which U.S. firms are domestically important and therefore need an additional layer of regulation. This problem could be avoided by simply stripping the Financial Stability Oversight Council of its ability to make these designations. More generally, regulators should not be permitted to pledge to their foreign counterparts that they will implement internationally developed standards in the United States.
The sixth core principle seeks to "make regulation efficient, effective, and appropriately tailored." The SEC, for example, can build on the Jumpstart Our Business Startups Act by looking for additional ways to tailor regulations for small, new public companies. In the banking sphere, inapt requirements, such as stress testing, could be eliminated for small banks. There are also opportunities to streamline regulation across companies of all sizes by paring back reporting and disclosure requirements that generate large compliance and recordkeeping burdens without commensurate benefit.
The final core principle focuses on making sure federal regulators are accountable and "rationaliz[ing] the Federal financial regulatory framework." In addition to the bank reforms mentioned earlier, the Office of Financial Research, the Financial Stability Oversight Council and the Federal Insurance Office – all Dodd-Frank regulatory creations – could be eliminated or their missions could be pared back. In the capital markets space, policymakers could consider the merits and feasibility of a merger between the SEC and the Commodity Futures Trading Commission.
Moreover, the role of so-called self-regulators should be reconsidered in light of changes in the markets and the increasingly governmental look of some of these purportedly private regulators. Regulatory accountability would be enhanced by uniformly subjecting financial regulators to congressional appropriations and ensuring that all of the agencies' enforcement, regulatory and supervisory actions meet due process requirements.
It is healthy to periodically review the regulatory system to identify opportunities for improvement. Reformers will find plenty of opportunity in the current financial regulatory system. To paraphrase the rallying cry for Dodd-Frank, it would be a shame to let a serious set of core principles go to waste.