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No need for new regulations; just wake up the regulators

The BP oil rig explosion and collapse in the Gulf of Mexico last month is prompting a reassessment of U.S. policy on deep-water drilling. It's also inspiring calls for more regulation.

Just as the subprime crisis exposed cracks in the financial regulatory system, so has the oil spill unearthed conflicts of interest at the Minerals Management Service, the agency in charge of offshore drilling. MMS, a bureau of the Interior Department, oversees the nation's natural gas, oil and other mineral resources on the outer continental shelf and issues offshore oil leases. It collects about $10 billion annually from the Gulf of Mexico region alone, according to its website.

Washington's answer to almost any crisis is bigger and better regulation. When is someone going to get it? The problem isn't the regulations. The problem is the regulators.

The Securities and Exchange Commission's enforcement division didn't pursue Bernie Madoff when Harry Markopolos handed them a complete dossier on what turned out to be the biggest Ponzi scheme in history.

The Comptroller of the Currency, which oversees national banks, had 50 to 60 regulators camped out at the big banks at all times. Apparently no one looked under the hood of the car.

The Federal Reserve, which regulates bank holding companies, had "hordes of observers" at the New York banks and at Bank of America, according to Fed historian Allan Meltzer, professor of political economy at Carnegie Mellon University in Pittsburgh. It knew banks were circumventing the Basel Accord's capital-adequacy requirements by moving risky assets off the balance sheet.

"The Fed didn't need explicit legal authority," Meltzer says. "Just say, 'stop doing that.' Banks don't want to have bad relations with their regulators."

Isn't it time we stopped trying to fix a nonproblem (creating new ones in the process) and fix a real one?

Let's start by getting "regular" out of the word regulator and put some panache in the job description.

No more tedious 9-to-5 days at the office surfing the Internet for porn. Regulators need a nice expense account to wine and dine bankers. Hire some foxes if you want the big boys to squeal. Nothing like a pretty woman across the table and a few martinis to make a Wall Street trader boast about his latest killing in the market.

Even more important, create the proper incentives for regulators to do their jobs. Institute an eat-what-you-kill compensation structure, just like that of Wall Street brokers, or "wealth managers," as they call themselves nowadays.

We need hungry regulators. Give them a financial incentive, and they'll have all the motivation they need to ferret out fraud, expose the perpetrators and make the Street safe for our children.

Make it clear regulators stand to benefit personally from any monies recovered from the fraud they detect. Forget Chris Dodd's financial reform bill. The various regulatory agencies will be competing with one another to see who can be first to nail the next Allen Stanford.

"An energized regulator can find many opportunities to intervene," says Vincent Reinhart, a resident scholar at the American Enterprise Institute in Washington.

Yes, he can. The Fed found the energy and opportunity last year when it summoned top bankers to review compensation practices. "The Fed said it had the scope to look into compensation because it affects risk management," Reinhart says.

Alas, regulators always manage to find their inner cop after the fact. The rules didn't change; the regulators did.

In good times, rules are interpreted loosely. Regulators tend to identify with the industries and firms they oversee, a phenomenon known as regulatory capture, and look the other way. Sometimes it's a matter of aspiring to that higher-paying private sector job. In other cases, a former industry executive at the top of an agency can make all the difference.

The Fed did try to address some of the more egregious mortgage underwriting practices by issuing guidance on subprime lending. Because the Fed has primary rule-writing responsibility for many consumer protection laws, including the Truth in Lending Act, its rules apply to all mortgage lenders, not just banks under the direct supervision of the Fed.

The rules and regulations were there for the asking. The problem was no one asked.

Now lawmakers are determined to rewrite the rulebook and go back to sleep. Unless they address the real problem and create the right incentives, regulators will go back to sleep as well.

Caroline Baum, author of "Just What I Said," is a Bloomberg News columnist.

© 2010, Bloomberg News

No need for new regulations; just wake up the regulators 05/22/10 [Last modified: Friday, May 21, 2010 8:16pm]
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