adventures in babysitting

I was listening to The Watchmen on This American Life last weekend - it affirmed my conviction about the sad, sad state of American regulatory oversight. The show is about financial services regulators and attempts to find out "who's to blame for this mess." It determines that one regulator was most "in charge" of many of the companies that failed most miserably.

It reminds me of a post a few months ago questioning whether our government has any regulatory insight at all, and then one that pushes our government to own it's own decisions. Listening to "The Watchmen" brought all this back, identified a potential scapegoat, and I think pointed to the real culprit.

A Fateful Year

In 1989 the Federal Home Loan Bank Board (FHLBB) was abolished by President George H. Bush and replaced with the Federal Housing Finance Board (FHFB) and the Office of Thrift Supervision (OTS). The FHFB regulates the 12 Federal Home Loan Banks, and the OTS regulates the Thrifts (providers of home loans).

Among others, here are some recognizable names that are managed by the OTS: AIG, Countrywide, GE, Ameriprise, American Express, Washington Mutual, IndyMac, and ING. I'm sure you've read about these fine institutions often in the last few months.

Around that same time, Alan Greenspan successfully pressured Congress into not legislating derivatives; and finally 1989 is also the year the Glass-Steagall Act was repealed by Congress.

Missed Intentions

But these were only the beginning. When the FHLBB was abolished, rather than start from scratch, the Administration did the worst thing possible. They ignored why things happened, just assumed it wouldn't happen again, and did the bare minimum. They appointed a new leader and changed FHLBB's name OTS - they did NOTHING else.

The real culprits (as is often the case) are not the front organization (OTS), but rather our elected representatives, who naively assumed that once the crisis was over, going back to business as usual would magically fix everything.

I haven't seen any Senate hearings on their own failings??? Gluttons for punishment that they are, the citizenry keeps reelecting these same culprits over and over again :-(.

What about the regulators?

Here's something I didn't realize: they are funded by those they regulate. Implication - the more companies they regulate, the more money they get. This is horrible!

Worse, when the new leader for OTS came on board, his mission was to expand his pie, and to do that he went on what amounts to a recruiting spree. He was aided tremendously by the fact that financial services companies can choose their regulator if they "qualify." For example - AIG, having learned about OTS' value proposition ("we're really flexible and generous with our oversight"), purchased a small Thrift (worth a mere one tenth of one percent of AIG), and was then able to elect to be regulated by OTS! Worse still, it was in OTS' best interests to keep a hold of as many of the old Savings & Loans as possible, which meant the most lenient regulator was regulating the worst offenders!

Is it any wonder that all of this combined with the creativity and ingenuity of traders, and the "you're only as good as your last deal" performance/compensation mentality, that things turned out the way they did?

So...

Should there be an organization that monitors the monitors? I don't think so - adding management layers never works well. What can we do instead??

First, it's pretty clear that regulators must be independently funded (via tax dollars), and that they must never solicit business (no lobbying or recruiting members). The hard one though is performance expectations (if you are what you measure, then how do we measure them?). Regulators are most effective when they're harmoniously (working well with their "flock") invisible, with their ideal result being a smoothly running machine.

What about real babysitters? A wage is negotiated, and the sitter is paid at the end of the job, provided the house is intact, and the kids are unwounded and asleep. If the sitter is good, then s/he gets more gigs, and because they're now in demand, their fees go up as well.

So... I propose an accelerated pay scale based on continued good results. Say they get 90% of current salaries as base. For every year their community is issue-free, their salaries go up 10% (1st year = 99%). If it remains issue-free in Y2, it's another 10% to 109%, and so on - by year five they're at 145% of base. We  bump it up by another 5% after five years so that the Y6 increment is 15% - then by Y10 they're up to 291% of base <-- not bad! But if an issue arises, they're back to 90% and have to start over. This might seem generous, but wouldn't you want great people in these jobs? You also want to make the pain of failure relevant. Moreover, think of the cost to taxpayers of the failure we've just experienced. The motivation then is to keep getting paid really well and increasingly better, provided the house remains intact, and the kids are safely sleeping.

Will this have the desired effect? I welcome your ideas...