The Federal Structure Of Financial Supervision: A Story Of Information-Flow
Hadar Yoana Jabotinsky
Hebrew University of Jerusalem Law School
May 23, 2016
Was Ben Graham's big purchase of GEICO shares actually a value investment? Perhaps it was contrary to what many believe. "In 1948, we made our GEICO investment and from then on, we seemed to be very brilliant people." -- Benjamin Graham, 1976 Both Benjamin Graham and Warren Buffett can attribute a large part of their Read More
This paper analyzes the financial regulatory structure of the US (federal level) from the point of view of information-flow. Two central discussions regarding regulation of the financial sector have been developing simultaneously: one regards the role of financial regulators in crisis prevention and mitigation, the other considers the efficiency of a consolidated versus a fragmented regulatory structure. Within these debates, operational problems have been largely ignored. Economists have traditionally approached the optimal structure of financial supervision from a public choice angle, focusing on different types of inefficiencies, including agency problems, capture of the financial regulator, monitoring, and self-interested regulators. These valuable perspectives sidestep an equally important public administration problem, namely the problem of information-flow within and among financial regulatory authorities. The novelty here is that this paper approaches the matter of the optimal structure for financial regulators from the standpoint of organizational design and information–flow. Furthermore, the article proposes a new theoretical framework for analyzing financial regulatory structures, and draws for this purpose on organizational theory. The article identifies the pros and cons of the different structures and offers a unique way to analyze them. It uses the US federal financial supervisory system as a case study, points out its strengths and weaknesses, and offers a solution to the latter.
The Federal Structure Of Financial Supervision: A Story Of Information-Flow – Introduction
“Paul Volcker, former head of the Federal Reserve, has issued a radical call for the US to follow the UK’s lead by streamlining its mishmash of financial watchdogs in order to close worrisome gaps in regulation…. The UK’s response to the 2007-09 financial crisis put more regulatory power in the hands of the Bank of England and Mr Volcker said the US should do the same by strengthening the Fed and consolidating other regulators. He called for the abolition of one of three main US bank regulators, the Office of the Comptroller of the Currency, and for the merger of two markets regulators — the Securities and Exchange Commission and the Commodity Futures Trading Commission. Arguing that regulators continue to lag behind the growing size and complexity of financial markets, he told a press conference in Washington on Monday: “All the evidence is that the time has come to do something.”…”
Paul Volcker is not the only one concerned with the federal financial regulatory system. Following the 2007-09 financial crisis many experts have voiced their concern and said that something must be done. The question is what?
The 2007-2009 financial crisis was probably the biggest financial crisis since the Great Depression. Billions of dollars’ worth of assets were lost, great and well established financial conglomerates, such as Lehman Brothers, AIG, Bank of America, Bear Stearns, Citibank, Freddie Mac, Fannie Mae and Merrill Lynch either went bankrupt or required special government assistance to survive. These catastrophic events reignited the discussion with regards to the role of financial regulators in crisis prevention and mitigation, and about the efficiency of consolidating them verses leaving them fragmented. These ongoing economic and legal discussions concern themselves with a positive analysis of the type of regulation needed. It is fair to say that by and large these discussions tend to ignore operational problems (such as the seemingly technical issues relating to the flow of information inside and among financial regulators).
This paper offers a novel approach to the matter of the optimal structure for financial regulators, and analyzes it from the standpoint of organizational design and information-flow (i.e. the flow of information from one layer of management to the other in a hierarchical regulatory institution or the transfer of information from one department to another inside the same financial regulatory institution or from one regulatory institution to another). Taking the US federal financial regulatory system as an example, it examines the key strengths and limitations of the federal financial regulatory structure and offers additional reforms that could improve financial stability. This paper further points out the operational side of information-flow, which needs to be taken into account when a country decides to change its financial supervisory structure.
Information-flow within and among financial regulators is so important, because decisions in general and regulatory decisions in particular depend on information. Financial regulators are expected to provide a cure for the agency and monitoring problems which exist in the financial markets. They are also expected to address issues such as consumer bias, and control the herding phenomenon which may lead to the creation of bubbles or runs on banks. In order to perform these tasks they are heavily reliant on information and on the information-flow inside the regulatory body itself. As information is such an essential part of regulatory work, it seems that without addressing the organizational issues concerning information–flow, the discussion surrounding the economic and legal analyses of the optimal structure for financial regulators may be missing a crucial factor. An example may be found in the latest financial crisis. This crisis has proven the need for fast flow of relevant information. Many countries undertook drastic measures to try and stop the financial crisis. These measures were based on information derived from the real-time advancement of the financial crisis. The analysis of this
information was transferred to the decision makers, who took decisions based on the information they received.
However, the importance of information for the regulatory work is not limited to times of crisis. Information is also needed on a day-to-day basis in order to perform the ongoing regulatory task itself. Take for example the reporting requirements from financial institutions. Some of these requirements are technical, and require financial institutions to report various matters on a quarterly or yearly basis, while others are substantive, and require financial institutions to report particular events. The logic behind all of these requirements is to provide the regulator (and in some cases, the public) with a better understanding of what is going on inside the regulated financial institution. Such better understanding enables the regulator to tailor its response to foreseeable problems prior to their occurrence. If the information is incorrect or partial, regulatory response will be less than optimal.
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