Building Better Regulators

There’s been a fair amount of talk lately about how regulators screw up (just like the right of us) and so we need to minimize discretion, etc. That’s all fair enough. But it’s also the case that not all public sector agencies are created equal. Something that isn’t getting discussed in the current legislative effort to improve financial regulation is how to we build better regulatory agencies, and how do we build agencies that have more social and political prestige in a way that makes it costly to interfere with them. The prestige issue is important. The President can always try to overrule career people, but whether he’s likely to get away with it—and whether his advisors are likely to think it’s a good idea—has a lot to do with which agency the career people work for.

Tim Fernholz touched on some of this yesterday:

One thing that could be done now to improve our regulatory regime, besides more focus on appointments, would be an amendment to the Senate financial reform bill, the “Regulatory Force Modernization Amendment,” or some such thing. It would bump up regulator and bank examiner salaries, provide more training opportunities, hire more diverse staff (read the Epicurean Dealmaker) and, hell, give them badges and an ethos. If we’re serious about improving our regulatory institution, we need to come at the problem from all angles.

Legislation is important, but it’s also worth noting that there’s a lot that can be done on this front that’s non-legislative. The “ethos” issue is especially important. If an FBI agent notices that there’s a group of Italian-American gentlemen who seem to spend most of the day hanging out in the back room of a strip club but who also sometimes meet with Columbian dudes in a warehouse and seem to be social acquaintances with street-level drug dealers, then he’s not going to say “well, nothing illegal about hanging out in the back room of a strip club.” He’s going to say “smells like mafia” and investigate.

This is not necessarily the ethos you want every public agency to have. You don’t want the guys at the state business licensing department to treat every piece of bad paperwork as prima facie evidence of a criminal conspiracy. Ideally, you want them to be helpful and make it clear to people what the right process is. But on banking, what we’d like to do is change the ethos from one of helpfulness to one of suspicion. There’s always going to be a concern that financial malfeasance is a bit like a balloon and if you squeeze hard on one aspect it goes and pops up someplace else. Which means that you need regulators—from the front-line personnel up to the heads of the agencies—who are proactive to an extent and understand themselves as upholding the idea of limiting risk and leverage, rather than enforcing a narrow conception of the rules. Obviously, regulators can’t stop people from doing things that aren’t actually against the rules, but if the issue is that regulators think people are exploiting a loophole they can always try to ask for new authority. That basically never happened during the late bubble, which is an issue of ethos.

What’s more, this is actually the kind of thing that I think Tim Geithner is ideally situated to understand and help spur. After all, unusually for a cabinet secretary he’s not a politician. He’s a former civil servant who rose to a high-level civil service job and then to a low-level political job and then a higher-level one, and then to the New York Fed and then to the cabinet. It’s not a typical career path, but it’s one that could be emphasized and leveraged to try to create a culture that does more to valorize public service and the idea of a job well-done in the public sector.