Overhaul the Financial Regulatory System

The U.S. financial regulatory system is a labyrinth of overlapping, duplicative, dysfunctional, and costly federal government agencies badly in need of fresh review and overhaul. With the possible exception of the healthcare industry, there is perhaps no business sector more heavily regulated in the United States than the financial sector.

 

The diagram above of federal financial regulators and their oversight responsibilities succinctly shows the overly complicated nature of the U.S. financial regulatory system. But big changes may be coming to this long-standing regulatory mess after the new Trump administration takes office next month.

According to a Wall Street Journal article on December 12th, the Trump transition team is exploring ways to dramatically downsize, consolidate, or even abolish some federal financial regulatory agencies. Excerpts from the WSJ article:

In recent interviews with potential nominees to lead bank regulatory agencies, Trump advisers and officials from his newfound Department of Government Efficiency have, for example, asked whether the president-elect could abolish the Federal Deposit Insurance Corp., people familiar with the matter said.

Advisers have asked the nominees under consideration for the FDIC, as well as the Office of the Comptroller of the Currency, if deposit insurance could then be absorbed into the Treasury Department, some of the people said.

Any proposal to eliminate the FDIC or any agency would require congressional action. While past presidents have reorganized and rebranded departments, Washington has never shut down a major cabinet-level agency and rarely closed other agencies like the FDIC that are not.

The discussions underscore the drastic approach Trump could take in his attempt to slash the size of the government and ease oversight, including for the highly regulated financial industry.

Potential bank regulator nominees have interviewed with Treasury Secretary pick Scott Bessent and the new DOGE department, the outside advisory group co-chaired by Elon Musk and Vivek Ramaswamy, some of the people said.

Musk last month also called for the elimination of the Consumer Financial Protection Bureau, an agency Republicans have long hated. “There are too many duplicative regulatory agencies,” Musk said.

Trump advisers and potential nominees have also discussed plans to either combine or otherwise restructure the main federal bank regulators: the FDIC, OCC and the Federal Reserve….”

As a former federal financial regulatory employee, I wholeheartedly endorse the abolition of both the FDIC and the CFPB. Both agencies are massively overstaffed, badly bloated, and heavily politicized. The regulations and compliance enforcement actions that they impose on the financial sector are burdensome, costly, and mostly counter-productive. (READ MORE from Steve Dewey: Turmoil at the FDIC)

The standard argument for the existence of the FDIC is its responsibility for providing deposit insurance for bank customers. However, there have been numerous studies since the FDIC’s creation in 1933 that government-funded deposit insurance establishes an inherent moral hazard that actually leads to more, not less, bank failures and financial crises.

In a study authored by Thomas Hogan and Kristine Johnson, “Alternatives to the Federal Deposit Insurance Corporation,” published in The Independent Review, Winter 2016, privatization of bank deposit insurance and the abolition of the FDIC were considered. Key excerpts from the study:

[T]hree potential changes that might be made to the current system of deposit insurance managed by the FDIC. First, international studies find that private or semi-privately managed deposit insurance systems tend to outperform public systems. The FDIC might therefore be partly or fully privatized in a manner similar to most European deposit insurance systems.

Second, the evidence shows that lower levels of mandated deposit insurance coverage tend to increase stability in the banking system. The current maximum level of $250,000 in mandated FDIC deposit insurance coverage can be greatly reduced without endangering the vast majority of depositors, a change that is likely to benefit smaller depositors by increasing stability and reducing costs.

Finally, we propose that mandated insurance could be eliminated and that the FDIC be privatized or abolished altogether. Historical evidence of deposit insurance prior to the FDIC indicates that private mechanisms, such as clearinghouses, coinsurance programs, and systems of self-regulation are likely to emerge to stem bank risk. The empirical evidence indicates that these proposals are likely to increase efficiency and stability in the U.S. banking system.

As for the CFPB, it was created in Title X of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act). The progressive Democrat sponsors of this legislation, former Senator Chris Dodd and former Congressman Barney Frank, were successful in setting up the CFPB to be uniquely independent of congressional budget authority and oversight. The CFPB’s funding, rather than being authorized by Congress, would come from the Federal Reserve and with funding amounts to be at the discretion of the CFPB itself. Thus, the legislation was crafted to keep the CFPB as free from congressional oversight as possible. (READ MORE: Back-to-Back Bank Closures: The Fallout From the Failures of Silicon Valley Bank and Signature Bank)

Legal scholar Peter Wallison, Senior Fellow Emeritus of the American Enterprise Institute, served as a member of the 1–member Financial Crisis Inquiry Commission (FCIC) established by Congress in 2009 to investigate and report on the causes of the 2008 financial crisis. Mr. Wallison was a dissenter on the final report issued by the FCIC in January 2011.

Subsequent to serving on the FCIC, Mr. Wallison authored a 546-page book on the Dodd-Frank Act in 2013 entitled “Bad History, Worse Policy.” In his book, Mr. Wallison was highly critical of the creation of the CFPB in the Dodd-Frank Act. He wrote:

Another provision of the Dodd-Frank Act that is derived from the left’s narrative is the Consumer Financial Protection Bureau, which was given authority under Title X of the act to police all financial relationships between consumers and firms of any kind — not just financial firms.

In the U.S. constitutional structure, Congress has the power to appropriate funds for the operations of the executive branch. However, the Dodd-Frank Act provides a unique funding mechanism for the CFPB, granting it a direct statutory allocation of funds from the Federal Reserve. So Congress has no power to control the scope of the agency’s activities through appropriations … although the CFPB’s funds come from the Fed, the Dodd-Frank Act forbids the Fed to exercise any control over the agency. In other words, the CFPB, alone among federal agencies (except the Fed itself), is free of any political or policy controls.

A much more recent and even more devastating indictment of the U.S. financial regulatory system was provided by the Bank Policy Institute just last month, November 19th, in an article posted on its website, “Bank Supervision is Broken. Here’s How to Fix It.” Excerpts from the article:

Banks are unique among U.S. companies because they are not only subject to intense regulation but also directly overseen by an army of well over 5,000 government examiners. The banking agencies refer to this function as “supervision,” and that term itself illustrates the problem: by statute, the agencies are only authorized to examine banks for legal compliance and unsafe and unsound practices, but over time they have expanded their function to now “supervise” and micromanage banks’ operations and governance, and increasingly dictate their business choices based on how the government thinks they should operate.

Furthermore, this power is subject to no checks and balances: “supervision” operates in secret based on the varying views of individual examiners, and the agencies have created their own enforcement regime, not based on rule or law, to impose significant penalties on banks that do not follow their mandates. These penalties can be severe and greatly affect the ability of banks to run their business; they range from limits on business growth, orders to divest from certain business lines and customers, denials of mergers and acquisitions and increases in deposit insurance fees, among other things.

The banking agencies are able to impose severe mandates on banks for one reason: they have established a secret enforcement regime that allows them to impose massive sanctions without any due process or, in most cases, public disclosure. In the past, and under the law, a banking agency’s only recourse to force a bank to change its practices was a formal enforcement order that came with a right of the bank to receive notice of the charges and contest them in court. Now, there is effectively no way for a bank to contest a supervisory mandate.

The above excerpts from the writings of highly credible financial regulatory experts supports the rationale of the Trump transition team in exploring a major overhaul and simplification of the nation’s financial regulatory system. But any overhaul can only be achieved while Republicans have control of both the Senate and the House of Representatives with a reform-minded Trump-Vance administration. Democrats en masse will surely oppose any major reforms that downsize, weaken, or abolish any federal regulatory agencies.

Steve Dewey is a retired federal financial regulator and founder of GeoFinancial Trends, LLC (www.geofinancialtrends.org). He can be reached at steve@geofinancialtrends.org

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