Restructuring U.S. federal financial regulation

Contemporary Economic Policy, July, 2007 by Rose M. Kushmeider

Since the mid-1990s, movement away from deposit instruments has accelerated. Consumers now hold as many assets in mutual funds as they do in deposit instruments. Direct holdings of corporate equities have also declined since 2000. Although growth of pension fund reserves has slowed, they now account for fully one-third of the financial assets of house- holds. Overall, the period 1945 through 2005 witnessed consumers shifting from directly holding financial assets (Treasury securities and corporate equities) to holding most of their financial assets indirectly (in mutual funds and pension fund reserves).

V. REGULATORY MODELS IN THE UNITED STATES AND ABROAD

The proliferation of new financial products and services has, in many ways, fostered change in the financial regulatory system. Despite the changes, however, including most recently those implemented by GLB, the U.S. regulatory system still assumes a financial marketplace, with well-differentiated products and services and with financial services providers that can be categorized by function. Many banking, securities, and insurance products and services, however, now overlap in purpose, effect, and appearance, and financial services providers have found numerous ways around the restrictions that attempt to confine them to particular regulatory niches. The result is that the dynamic financial marketplace is creating organizations that, it is argued, operate as unified entities--but are subject to the oversight of a comparatively static and complex regulatory structure that looks largely at the individual pieces. In considering how to regulate these increasingly complex entities, choices have to be made about the division of regulatory responsibilities and which supervisory model is most appropriate. (16)

A. Strcutural versus Functional Regulation and the Evolution of the U.S. Regulatory System

Structural or institutional regulation is characterized by having a single agency exercise all of the different types of controls applicable to a financial firm operating in a distinct market segment. It allows a single supervisor to examine a firm's operations as a whole, to evaluate risk across product lines, and to assess the adequacy of the firm's capital and operational systems that support all the business lines. In structural regulation, integrated supervisory and enforcement actions can be taken, which will address problems affecting several different product lines.

By focusing on the entire entity, structural regulation can mitigate the potential for overlap and duplication caused by having multiple sets of laws and regulations and multiple supervisors. It works best when financial firms offer distinct products and services. For institutions whose products and services cross market boundaries, however, structural regulation can engender distortions in the ability of firms to compete. This can occur when regulators interpret laws and regulations that affect these products and services differently. Ultimately, this can lead to calls for "a level playing field."