In my book I suggested a moratorium on financial regulatory reform: wait until the economic recovery is well under way and the causes of the financial crash have been well studied. There is no urgency about financial regulatory reform because there is no imminent risk of another crash. For a time at least, the world's central bankers, and the financial industry itself, will be hyper-alert for another housing or credit bubble. The wisdom of delay is confirmed, in my eyes at least, by the proposals in Financial Regulatory Reform, the lengthy "white paper" issued last week by the government.
But given the pressure to "do something," I shall make a few proposals, guided by the principles that structural reform--creating new agencies, shifting regulatory power from one agency to another, and the like--is unresponsive to the problems of regulation that the financial crisis has brought to light, and that, in light of our as yet imperfect understanding of the causes of the crisis, modesty should be the watchword.
The first proposal is to commission an in-depth study of the causes of the financial crisis, along the lines of the study by the 9/11 Commission of the intelligence failures that enabled the 9/11 plotters to elude detection. The essential point is that the in-depth study be conducted by neutrals rather than by persons who had an official role during the run-up to the financial crisis. The analysis and recommendations in Financial Regulatory Reform are contaminated, as it seems to me, by the complicity of some of the authors (or officials who shaped the analysis and recommendations, whether or not they contributed to the drafting of the Report itself), in the regulatory failures that largely caused the crisis. Instead of acknowledging the causal significance ot these failures, the Report tries to shift the blame to the private sector and to structural deficiencies in regulation that--the Report argues unconvincingly--prevented the regulators from anticipating and preventing the crisis.
My remaining proposals are of measures to improve regulatory performance, as distinct from the organization of financial regulation. First, we need a program that will rotate financial regulatory staff among the different financial regulatory agencies, to broaden the perspectives of regulators, reduce the "stovepiping" of information that may relate to a wide range of companies and financial markets, expose regulators to new ideas, reduce turf warfare based on misunderstandings, and make a career in financial regulation more interesting and challenging. The model is the military reforms, instituted by the Goldwater-Nichols Act of 1986, that made service in joint commands a prerequisite to promotion to a senior level.
Second, it would probably be a good idea to finance the financial regulatory agencies out of congressional appropriations rather than fees paid by the regulated firms. The fee system puts the agency and the regulated firms in the approximate relation of seller to customers, and let's not forget the slogan that the customer always knows best. The particular danger is that a firm will, by configuring its structure in a particular way, bring itself under the jurisdiction of an agency that, desiring to increase its fee income, offers (implicitly of course) a softer regulatory touch. There is the further danger, when an agency is supported out of fee income, of a mismatch between the penalty function of fees and the revenue function. Fees set at the right level to deter risky practices may generate too little or too much income to finance the agency at optimal size.