April 17, 2006
Government Expenditures and Financial Services Regulation
Posted by Elizabeth Brown

I would like to thank Gordon, Christine and Vic for allowing me to participate on this blog for the past two weeks.  I have enjoyed it immensely.

Since most people have to either file their taxes or their request for an automatic extension by today, I wanted to close with a final thought on one area that effects taxes, namely government expenditures, and a way that these expenditures could be reduced by the consolidation of financial regulators.  I have an article entitled E Pluribus Unum – Out of Many, One: Why the United States Needs a Single Financial Services Agency, which is coming out soon in the University of Miami Business Law Review.  In the article, I argue for consolidating the over 115 federal and state agencies that regulate banking, insurance and securities into a single financial services regulator similar to the UK's Financial Services Authority.  The U.S. system of financial regulation is by far the most expensive system in the world. It costs 12 times more than the United Kingdom's system after accounting for the differences in the GDP of each country.  The U.S. system, however, is not 12 times more sound than the U.K.'s system. Consolidating the U.S. financial services regulators could lead to significant cost savings without incurring significant harms to the effectiveness or soundness of the U.S. financial services industry.  In addition, a single financial services regulator would be able to address many of the problems inherent in the current regulatory regime, which include an inability to anticipate and plan for future financial crises, an inability by regulators to quickly adapt to market innovations and developments, inconsistent regulations for financial products and firms that are competitors in the financial markets, and the capture of agencies focused on a single sector of the financial services industry by the firms that they regulate. The funds that the federal and state governments could save by eliminating the existing duplicative regulatory structures could be better spent elsewhere and might help reduce the need to raise taxes in future.

Opponents of this type of consolidation usually argue that it would lead to agency capture and would eliminate regulatory competition. I deal with both issues at length in the article.  I would like to note a few things here with regard to these issues. First, agency capture tends to occur more frequently in agencies that are focused on a narrow sector rather than those cover a broader range of sectors.  So regulator that covers a broader range of financial firms, which do not necessarily share the same regulatory goals, is less likely to be capture by any one group of firms. 

Second, the benefits of regulatory competition have been exaggerated.  For example, the regulation of insurance is solely at the state level and unlike the market for incorporation, the states do not compete with one another because each has a monopoly over the licenses for selling insurance within its borders. Even the dual banking system does not result in significant regulatory competition in part because (1) the federal government agencies can exercise their powers of preemption under the Supremacy Clause to prevent any significant loss of market share to the states, (2) state banks are subject to a federal regulator because they must obtain FDIC insurance in order to be competitive, and (3) 34 states have laws that automatically extend regulations adopted to benefit national banks to state banks. 

Finally, in the marketplace of ideas, no one is moving to adopt the U.S. system of numerous financial regulators.  In fact, the movement is in the direction of consolidation.  Over the past 20 years, at least 50 countries have either created a single financial services regulator or a semi-integrated regulatory structure for financial services by consolidating the regulation of at least tow sectors, either banking and securities, banking and insurance, or securities and insurance, into one agency.  Consolidation of financial regulators is already occurring at the state level. Thirteen states and the District of Columbia have created a single agency to regulate all financial services and fifteen states have adopted a semi-integrated agency to regulate two financial services sectors.  The reasons given by the states for moving in this direction generally are that such consolidation will result in better regulatory efficiency and effectiveness than a system of separate regulators and such consolidation will save the state money.

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