07/12/2009 05:12 am ET Updated May 25, 2011

Paying The Price Of Fragmented Regulation

Isn't Washington wonderful? In the run-up to testimony by Bank of America chief Ken Lewis on the Merrill Lynch & Co. affair, e-mails are suddenly leaking from the Beltway colander, though their ultimate source, strangely enough, is that opaque wonderland, the Federal Reserve.

The New York Times and the The Washington Post get their bundle of e-mails from, of all places, "Republican Congressional staff members," while the The Wall Street Journal describes the provenance of its even juicier bits as "emails and other documents, subpoenaed from the Fed as part of a Congressional investigation led by Edolphus Towns (D., N.Y.)" and included in a transcript "reviewed by Dow Jones Newswires."

From a media perspective, there are all kinds of speculative fodder there. Were there two different leaks? What are the politics here? Were Republican staffers giving this material out a) to be nice, b) to be fair or c) to spread embarrassment of any part of the government involved with bailouts and thus sow confusion into the unfolding regulatory reform process? Or does the GOP just want to torture Lewis? Why Dow Jones Newswires? Generally, the e-mails present the Fed perspective, which makes you wonder whether the central bank had a role in disseminating them, which runs against the embarrassment thesis. The e-mails certainly have gotten publicity for Towns' hearings. Is Eliot Spitzer mixed up in this?

One thing is clear, ably articulated by John Gapper in Thursday's Financial Times: The regulatory reform process has run amok. Not that that hasn't been obvious for a while now. Gapper, however, links two episodes as part of a unified dysfunction: The fight among regulators over Vikram Pandit's competence (FDIC anti-Pandit vs. Fed pro-Pandit, with Treasury waffling and the White House, meaning Larry Summers, lurking) and the not-so-subtle maneuvering over regulatory precedence in a post-reform system. Gapper's point is well taken. For all the latter-day arguments about how a fragmented regulatory system provides redundancies, second opinions and protections against capture, it also generates remarkable opportunities for friction, infighting, data hoarding, turf wars and general dysfunction. The tempest over BofA, which has clearly been sucked into a larger war for bureaucratic supremacy, is another example.

By the way, no one knew how to manipulate this system better than the aforementioned Spitzer.

A third example: The Securities and Exchange Commission. The WSJ also has a generally admiring piece Thursday about how the SEC's Mary Schapiro is doughtily battling for not only the SEC to survive, but to get a place at the high table (this is the bookend to a New York Times piece last week making an argument for the Commodities Future Trading Commission). Schapiro bases much of her argument on defense of shareholder rights. Schapiro fought hard to retain mutual-fund oversight, for instance, and wants to retain the power to wind down nonbank financial institutions rather than giving it up to a more-powerful FDIC. And she's pushed for a council of regulators, fearful of giving too much power to the burly Fed, which, unlike the SEC, the WSJ writes, "doesn't have a mission of protecting investors."

Like the CFTC and its Chicago futures crowd, the SEC is making its case on the back of a single constituency, investors. True, back in the New Deal '30s, the SEC was given that overriding mandate, which made sense given that investors had very few protections. But part of the SEC's decline stems from its tortuous attempt to define investor interests in a financial system that has grown far beyond individuals buying stocks. In a world dominated by sophisticated, often global, institutions and large investors wearing many hats, the SEC has long perpetrated a fiction that it existed to make sure Aunt Mary didn't get screwed by a broker selling fraudulent tech stocks. The SEC may have fumbled enforcement, not to say tech stocks, but in the past decade or so it got increasingly lost in a conceptual maze on basic issues like transparency, disclosure, competitiveness, governance and accounting. The nadir may have been reached in the Christopher Cox era, when the agency whiled away the time trying to balance off interests to produce a Zen-like passivity.

"Investor protection" is now more a slogan than anything else. And the fact that the SEC calls for a key regulatory role -- but hardly acknowledges what are clearly legitimately competing interests to the mythical small investor in a large and complex system -- tells you a lot about what's happening.

A final point, which brings us back to BofA, Citi and the banks. Clearly, the banks themselves are lobbying like crazy to get their own interests served, providing even more pressure to fragment rather than streamline. But how irrational is this? For decades, bankers large and small have groused about inefficient, cumbersome, annoying, distracting regulation. But like the tax system, mounting complexity drove them to battle back with larger and larger lobbying efforts, which, in a paradoxical turn, created more rules, more loopholes and more and different regulators (financial innovation has the same paradoxical effect). One would think that the banking establishment, among other large financial interests, would now crave a simpler, more logical regulatory system with rules that were not so intricate and ambiguous that even they could hardly tell when they were not in compliance with them. At the very least, it would keep down the leaks.

Just a thought. Probably more like wishful thinking. - Robert Teitelman

See story about Lewis testimony from Dealscape

Robert Teitelman is the editor in chief of The Deal.