The US Regulatory Environment
The US financial regulatory system is a complex collection of laws and regulations, all developing out of a complex history of competing ideologies and reactions to financial turmoil. Starting this week, we’re going to look at various aspects of the US regulatory system, including regulations, regulatory institutions, banking structure, and the infamous “check”. To begin, we take an overarching look at the history of the US financial system, major pieces of regulation, and how the ideals of a revolutionary era resulted in a regulatory system without the power to handle systemic problems.
A Brief History of the US Banking System
The role of the US at the heart of many of the modern global crashes has resulted in a view of the state as lawless, but there have been major pushes to regulate financial institutions from the very start of the union, in a way that regulated banking would play a pivotal role in US politics. However, an ingrained resistance to centralized power born out of the revolutionary spirit of the founding fathers, has resulted in a number of disconnected institutions, each to resolve a particular problem, as opposed to sweeping systemic changes.
1789 – The Department of the Treasury is founded
1791 – The First Bank of the United States is formed, it closes twenty years later in 1811, having failed rechartering during the rise of the anti-federalists.
1799 – Thomas Jefferson founds the Democratic-Republican party. At its core: resistance to centralized banking.
1816 – The Second Bank of the United States is formed. Its founding would be a major issue in the reelection of Andrew Jackson, who opposed central banking. It would also be the largest monied corporation in the world until its close in 1841.
1863 – Congress passes the National Bank Act (with the second in 1864), giving rise to the dual banking system, and forming a national currency. This also established the Office of the Comptroller of the Currency, as part of the Department of the Treasury.
1907 – “Wall Street Panic” occurs, nearly crushing the US banking system as the banks run out of money. The US is bailed out by J.P. Morgan, triggering calls for both greater financial regulation, and solutions in case this happens again. The Federal Reserve is conceived.
1913 – The Federal Reserve act is passed and the Federal Reserve is born.
1929 – The Stock Market crashes, triggering the great depression.
1932 – the Glass-Steagall Act is passed, expanding the power of the Fed.
1933 – The Banking Act of 1933 is passed, expanding Glass-Steagall Act. It establishes the Federal Deposit Insurance Corporation.
1934 – the Securities Exchange Act established the Securities and Exchange Commission (SEC), and puts further regulation on the secondary trading of securities. The Federal Credit Union Act is signed, creating the Bureau of Federal Credit Unions. This would eventually become the National Credit Union Administration.
1936 – The Commodity Exchange Act passes, creating CFTC.
1940 – The Investment Company Act (or Company Act, or ‘40 Act) passes, regulating mutual funds and closed-end funds. Meanwhile, the Investment Advisor Act is created to monitor and regulate the activities of investment advisers. It is administered by the SEC.
1999 – Glass-Steagall is repealed, in ordered to stabilize the financial services system and make it more competitive in global markets. The effectiveness of this is hotly debated in modern American politics.
2008 – The collapse of the CDO market in the US results in the “Great Recession”, creating calls for increased financial regulation.
2010 – The Dodd–Frank Wall Street Reform and Consumer Protection Act is passed. This whopper of an act, makes massive changes to the regulatory environment of the US, creating the Financial Stability Oversight Council, the Office of Financial Research, and Consumer Financial Protection Bureau.
The US Regulatory System:
As shown above, the United States has a tradition of individual regulators corresponding to each category of financial regulation, as opposed to single regulators with authority over large swaths of financial markets, activities and institutions.
The regulations they enforce often focus on either prudence or disclosure. For example, banking regulation is usually focused on prudence, whereby their business decisions are regulated for safety, and sound business practices. On the other hand, firms that sell securities to the public, must register with the SEC and disclose any material risks to the regulators. Such disclosure doesn’t assure an investment is prudent, only that material risks have been disclosed. Organizations like the Commodity Futures Trading Commission oversee trading on futures exchanges, which have self-regulatory responsibilities.
Under this model, a particular event within the financial industry may be regulated by multiple agencies, as firms will be subject to both activity-based regulation and institution-based regulation.
This has created problems for US regulatory agencies. For example, when JPMorgan’s risk management unit, CIO, had significant losses on trades of complex derivatives, people demanded to know what regulator JPMorgan fell under, and what had failed. The answer was that there had been a different regulator for each aspect of the trade. At the depository level they were under the prudential guise of the OCC, the Federal Reserve at the holding company level, because they are a public company their trades of their stock holders were regulated by the SEC, as a participant in the derivatives market they were subject to the CFTC, and as an insured depository institution they were subject to the FDIC.
Because of situations like this, there has been a new push for systemic regulation. The Dodd-Frank Act created FSOC (which now permanently monitors systemic risk) which has consolidated bank regulation agencies (from five to four), and consumer protection rulemaking under the new Consumer Financial Protection Bureau. It has also granted the CFTC and SEC authority over large derivative traders.
Murphy (2015) provides a useful breakdown:
Overview of Federal Financial Regulators
|Prudential Bank Regulators||Securities and Derivatives Regulators||Other Regulators of Financial Activities||Coordinating Forum|
|Office of the Comptroller of the Currency (OCC)||Securities and Exchange Commission (SEC)||Federal Housing Finance Agency (FHFA)||Financial Stability Oversight Council (FSOC)|
|Federal Deposit Insurance Corporation (FDIC)||Commodities Futures Trading Commission (CFTC)||Consumer Financial Protection Bureau (CFPB)||Federal Financial Institutions Examinations Council (FFIEC)|
|National Credit Union Administration (NCUA)||President’s Working Group on Capital Markets (PWG)|
|Federal Reserve Board (FRB, or the Fed)|
Chart Credit: “Table 1. Federal Financial Regulators and Organizations”, Who Regulates Whom and How? An Overview of U.S. Financial Regulatory Policy for Banking and Securities Markets, Murphy, E., Congressional Research Service, Jan. 30th 2015 https://www.fas.org/sgp/crs/misc/R43087.pdf
Created out of the National Banking Act, the Dual Banking System denotes the presence of both smaller, state controlled banks and large national banks. These are chartered and regulated by different agencies and laws, with the national banks being regulated under federal law and agencies, and state banks under the supervision of the state supervisor.
This permits the co-existence of two different regulatory structures, and results in differences in how credit is registered, in legal lending limits, and more, varying from state to state.
In part 2 of The US Regulatory System for European Treasurers, we’re going to dive a little deeper into the dual banking system and how its effects have had widespread repercussions for corporate banking.
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