Bear Stearns Collapse and the Banking reform of 2009

When the collapse of Bear Stearns broke, every commentator said that the Sarbanes-Oxley Act of 2002 regarding public company accounting reforms would be nothing compared to the banking reforms that stem from this collapse. Yesterday on CNBC Squawk on the Street Massachusetts Congressman Barney Franks, Chairman of the House Financial Services Committee, talked about the urgent need for banking regulatory reform. Franks called the current system haphazard and complicated. He is right.

Currently, there are half dozen agencies overseeing the various banking sectors from investment banking to commercial banking. The Security and Exchange Commission (SEC) regulates the investment banks and Congress established them as the new regulatory body for many portions of Sarbanes-Oxley. The Federal Reserve has primary supervisory authority of state banks which are members of the Federal Reserve. The Federal Deposit Insurance Corporation (FDIC), a government agency, responsible for guaranteeing deposits of $100,000 or less and supervises all state banks not members of the Federal Reserve. The Office of Thrift Supervision oversees federal saving banks and federal saving and loans; and the Office of the Comptroller of the Currency now regulates 1710 national banks and 50 federal branches and agencies of foreign banks. Under the Lincoln Administration, Treasury Secretary Samuel Chase wanted to have a national currency printed by national banks not the government in order to finance the Civil War; hence its name and role to control the currency. In the US, national banks are basically banks with the word national or national association in their title or have the letters NA or NT&SA following their title like Bank of America NA. The last two are agencies of the US Treasury. Frankly, by the time one can understand who has jurisdiction over which portion of the financial industry, one should go nuts.

Given the amount of overlapping authority in US financial institutions, it is not unreasonable for Congress to reform and simplify the jurisdictions of all banking regulators instead of establishing a new Treasury agency for the purposes of regulating financial risks as suggested by Franks. By this I mean the vast majority of the 1710 national banks currently under the regulatory control of the Office of the Comptroller of the Currency are also member banks of the Federal Reserve. The purpose of each government supervisory and regulatory body should be clear. The SEC should regulate stock markets and corporate governance. The Treasury Department should have a single agency to regulate and supervise all US operations of foreign banks and share responsibility with the Federal Reserve for maintaining a consistent regulatory environment across the banking sector, so that both foreign and domestic banks are operating under the same regulations. This would leave the Federal Reserve with several roles. Firstly it is the government's banker and the lender of last resort. Next, it controls interest rates. Lastly, it is the regulatory authority for all publicly traded domestic banks including investment banks and prime lenders. The principal reason that domestic prime lenders and commercial banks should be under a single regulatory authority is the convergence within the financial services sector, especially within commercial banking and prime lending. The merger of JP Morgan and Chase Manhattan Bank and the Citicorp with Smith Barney demonstrate that banks today need to offer greater services to it customers from personal banking needs to commercial and investment banking.

In the process of exiting its regulating role for saving and loans and domestic national banks, the Treasury Department could focus on managing the IRS and the public debt, advancing American economic interest at home and aboard, protecting the currency and combating illegal financing. I mean there are plenty of responsibilities for the Treasury even without its regulatory and supervisory role in certain elements of the US financial services industry. Most importantly, the consolidation of bank regulators under a Federal Reserve led regime would also mean that it is no longer subject to the politics of Washington. Currently Wall Street has a non-partisan regulatory body in the SEC; banks should enjoy the same privilege under the Federal Reserve.

One Bear Stearns economist blamed the Federal Reserve's inaction for the collapse of the venerable Wall Street firm and said had the Federal Reserve acted quicker, Bear Stearns might not be in the sort of trouble it got itself into. The sad truth is that the Federal Reserves have no responsibility for prime lenders and investment bankers. The principal regulatory authority for prime lenders and investment bankers is the SEC. Clearly, the SEC was asleep at the switch. Unfortunately, the SEC could not lend $30 billion to rescue Bear Stearns and Federal Reserve could not make such a loan available without the participation of a state member bank like JP Morgan Chase. Frankly, what was that economist thinking or smoking when he blamed the Fed for inaction? Bear Stearns CEO told the world on CNBC that Bear Stearns was financial sound on the Wednesday before the Friday that he had to inform the Federal Reserve of Bear Stearns’s bankruptcy.

Assuming Congress would give the Federal Reserve jurisdiction in investment banking, it would not hinder the SEC's mission of ensuring corporate governance and regulating stock markets. Furthermore, it would still have a role to play in regulating the numerous mutual and hedge funds. Also, the notion of separate regulatory agencies for the commercial and investment banks stem from the Glass-Steagall Act, when a bank could only serve as an investment bank or as a commercial bank, but in 1999, Congress repealed the Glass-Steagall Act. Hence, Congress created the SEC to regulate investment banks and later mutual and hedge funds. The role of the Office of the Comptroller of the Currency and the Federal Reserve are to regulate the commercial banks. However, consolidation of the banking industry as a result of the Gramm-Leach-Blliley Act has not followed up with additional legislation to the regulatory authorities in line with the transformation and creation of financial supermarkets like Citigroup or JP Morgan Chase.

With a Federal Reserve regulatory regime, it would greatly streamline the current mess of alphabet soup. At the same time, it would allow the Federal Reserve the liberty to act in times of crises within the financial sector.