Regulation: US plans single regulator - not

The USA's regulatory regime is a shambles. Even at Federal level.

The reason is that that, in essence, the US system of regulation is to divide the work up horizontally for some purposes - so regulation across the whole financial sector for e.g. money laundering is undertaken (in significant measure but not entirely) by FinCEN but vertically for others - so, for example, prudential regulation is undertaken by what amount to industry bodies often run by the industry itself as self-regulatory organisations.

In short, regulation has failed to keep pace with the changing nature of financial services companies' structure.

The USA has, until now, remained obsessional about defining the activities of financial institutions with regard to terms - despite the demise of the Glass-Steagal Act and the implementation - some eight years ago - of the Gramm-Leach-Bliley Act which authorised US wide complex financial institutions.

Of course, what underpinning Geithner's comments were a recognition that the USA has tried to increase the competitiveness of its banks by sidelining many of the measures of Basel II designed to control risk - including greater capital adequacy ratios. The US Treasury, operating as banking regulator, has expressly exempted many of its banks from some of the more stringent measures and given many more, including its biggest, options on much of the balance.

As financial services businesses have pushed an agenda of consolidation and convergence, the regulatory regime has let them get on with it, neither knowing nor, seemingly, caring what risks were being hidden in the name of growth.

Prior to GLB, banks were finding ways to avoid the restrictions of Glass-Steagal which ensured that banks operated in single state units and were not combined with other types of financial services entity. But national banking groups were formed under an umbrella holding company. Indeed, the structure of holding company / bank remains the norm for many of the USA's smaller banks, including those operating within single states.

In some cases, the structure is to increase tax efficiency - in effect running the holding company in another state creates the benefits of being offshore without the criticism that would bring.

In other cases, the holding company has been used as the parent for a complex financial group involving insurance, retail, corporate and commercial banking, stockbroking and investment and merchant banking.

After GLB, it was permitted to merge e.g. all the retail banks in multiple states into a single entity.

But Geithner's plans do not go far enough: investment vehicles should all be subject to full and effective regulation - but he wants to exclude most funds, focussing on the larger ones. And he wants them to register with the SEC.

He wants to establish a single entity that will supervise the stability of major institutions - and to apply more intrusive supervision. But this is weak: all federally supervised institutions should be subject to the same standard of supervision, not just the big ones. And the single entity should supervise the industry as a whole, not parts of it. Therefore registration with the SEC for funds should be with that single entity, and the SEC should be subsumed into it.

He wants to prevent the "too big to fail" concept by making larger companies carry larger reserves. But this should already have been done under Basel II, but successive US governments have pandered to vested interests which have argued that they should avoid such.

Basel II is a result of detailed study on convergence. Yes, it is ridiculously complicated and needs to be radically simplified. And it needs to be written by real-world risk assessors not by theoretical economists (as much of it appears to have been).

But mostly, it needs to be adopted.

Geithner's speech yesterday moves some way towards that. But clearly the US financial sector still holds far too much sway in Treasury and his words are hollow: if he really wants to fix the industry, he needs to take a far firmer stand, radically overhaul the complex and expensive regulatory system so as to make it simpler and cheaper to both understand and comply with.

He did say that strict capital requirements would be enforced which would reduce risk. Of course, that relies on two things: effective auditing (which has been notably absent in many of the basket cases around the world, leading to a serious questioning of whether audit has any real value) and effective supervision and enforcement.

In a world where inspectors are inexperienced, often junior and sent out with a tick-list to check against) and enforcement is negotiated rather than imposed (a trend the USA has pushed around the world) that effective supervision and enforcement has, so far, been sadly lacking.

There was little in Geithner's statement to indicate that, in the real world, things will really change. There will be a lot of noise, some shouting and squealing but, before the end of this crisis, there is no doubt at all that things will be back to normal, a normality where the financial institutions are not so much too big to fail as engaged in business that is too complex to understand and - rather like modern jazz - anyone who says "this is just noise" is accused of not having the intellect to understand it.

Strange, then, that the unimaginative (i.e. prudent) financial institions which did not get into business they did not understand are the ones who are not now fighting for their lives.