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Regulatory Reform Leaks Begin

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Regulatory reform is moving, but in flux, and sources are in full leak mode, which the Wall Street Journal demonstrated Thursday. David Wessel in his Capital column in Thursday's paper pretty much echoes the conventional wisdom about the Federal Reserve as a central systemic or "stability" regulator. Despite the sense that various regulators are whispering this and that, most of this uber-Fed chatter is pretty old hat, though Wessel fails to touch on the single thorniest question: governance. Will an all-powerful Fed -- and a stability regulator without sweeping powers to set capital is useless -- retain its traditional autonomy, or will it take orders from Treasury, the White House and Congress? In short, in receiving these great powers, will the Fed lose one of the things that makes it unique?

Meanwhile, right next to Wessel on the WSJ's A2, Damian Paletta in a news story reports that "top Obama officials" are close to reporting to Congress that a single banking regulatory be formed by merging functions of the Office of the Comptroller of the Currency, the Office of Thrift Supervision, the Fed and the Federal Deposit Insurance Corp. (Wessel seems to have written his column without knowing Paletta's reporting.) There is a logic here, as Paletta says: "Banks are overseen by a patchwork of state and federal regulators, and the Obama administration isn't expected to propose getting rid of the so-called dual banking system." But the plan would reduce the age-old tendency to shop for the lightest -- or most convenient -- regulator.

This is a significant change, particularly for the Fed, which has long supervised the largest, most important commercial banks. The Fed really drove the process of bank M&A, diversification and consolidation over the last few decades. And the Fed has long argued the traditional central bank position that it had to hold sway over banks because they were conduits for monetary policy. Is that no longer relevant? The notion that the U.S. needed larger, more competitive and efficient banks really had a home at the Fed for many years, which may have contributed to its failure to pay serious attention to mortgage lending.

This consolidation of supervisory function takes a powerful weapon from the Fed. If Wessel is right -- and there have long been many interests pushing the Fed as systemic regulator, although that inevitability felt like it was eroding recently -- the central bank may be handed new powers that will more than make up for what it loses. What's being constructed here is a shift from a Balkanized system based on a variety of criteria (geographic, function, structure, history) to a simpler, broader pyramidal scheme based on levels of supervisory powers. You can envision a system in which a set of institutions -- a consolidated banking regulator, some combo of the Securities and Exchange Commission and the Commodities Futures Trading Commission -- handles disclosure, examination and enforcement. On top of all that, however, would loom a stability or systemic regulator, with the ability to set capital requirements, which is essentially the power to turn the temperature of the entire financial system up and down. The Fed would then have even greater sway over all finance, while giving up supervisory powers it really didn't seem to embrace anyway.

Still, there are many questions raised by reading these two stories side by side. What will be the relationship between the systemic regulator and more prosaic supervisors and enforcers? How will information flow in this system? How transparent will it be? (The Fed has grown more transparent, but will it allow secret deliberations on individual banks to be disclosed?) Given this immense power, how could Congress and the White House allow some variation of the Federal Open Markets Committee to make decisions individually or systemically on capital? And what about the FDIC? The trade-off for the FDIC may well be that it gets greater capital and powers to seize failing banks, thus filling the role the Fed rushed into during the Bear Stearns Cos. implosion, and a role independent of the systemic regulator, in exchange for its loss of supervisory powers. But can the FDIC operate effectively without the intimate knowledge that comes from active supervision?

There are a handful of fundamental questions about the viability of financial regulatory that require answers that remain unanswered. How do we avoid, or at least minimize, the possibility of regulatory "capture," particularly in a competitive global system? And what's the relation between the public, and the political world, and the uber-regulator that sits atop this bureaucratic heap? The two are deeply intertwined. The very fact that Wessel really doesn't bring up either one of them suggests that for his whispering sources, some issues are better left unsaid.

Robert Teitelman is the editor in chief of The Deal.