The regulatory controls and deposit insurance system put in place in the wake of the Great Depression created a sound financial system almost century ago. But these reforms have been made obsolete by changes in markets, a revolution in technology and rampant inflation due to failed fiscal and monetary policies.
Congress belatedly and half-heartedly rewrote the regulatory script in 2010 after another round of financial stress occurred in 2008 and 2009. Seeking ways to maximize the overall health of a complex financial system, Congress created the Financial Stability Oversight Council, or FSOC. But the financial stability that the council was supposed to find remains elusive. Five fundamental challenges have stood in the way of that quest.
First, the FSOC is poorly constructed. The assumption was that the nearly a dozen siloed federal regulator,s, overseeing different financial sectors in America could adequately address the overarching issues that threaten the health of the system. But the idea of forming a new agency consisting of those regulators to grade their own work with no rulemaking or real enforcement authority should have been dead on arrival. FSOC should be eliminated or reconstituted with real objectivity and independence and more effective enforcement tools.
Second, regulation is just a slice of the risk. Congress doesn’t seem to grasp that neither the economy nor the financial companies that function in it look anything like they did in the 1930s. As just one example, banks and similar depository financial institutions were the prime movers of the economy then. Today’s financial services markets are dominated by non-banks, fintech, and mutual, money market, hedge, and private equity funds all vying for the same consumer dollars.
With nearly $5 trillion in unregulated cryptocurrencies and crypto derivatives instruments created largely by Wall Street, regulated banks are no longer the dominant superpower in the financial services marketplace.
Companies either lightly regulated or not regulated at all now claim significant shares of deposit and lending markets. That is a perfect formula for the next financial debacle.
Third, you don’t need much imagination to predict what happens when unscrupulous and unvetted individuals are allowed to solicit consumer funds and use them however they want. The nearly complete absence of regulation of the crypto and digital asset business, with no oversight or approval process over who can run those businesses, is guaranteed to magnify the risks to the public.
It doesn’t make sense that bankers must submit to detailed checks of their integrity and experience while crypto-kings like Sam Bankman-Fried and Changpeng Zhao can start a crypto business any time they want with little or no oversight. The disclosure that a crypto exchange like Binance became an instrument to finance global money laundering, human trafficking, child sexual abuse material and terrorism should have been anticipated. And the swindles performed by executives on customers’ funds at failed fintech companies are par for that course.
As these unsupervised businesses become large enough to affect the financial stability of traditional markets — something they are already perilously close to — a massive financial threat will be staring us in the face.
Fourth, deposit insurance is broken. The collapse of Silicon Valley Bank in the wake of a social media-driven panic tells us that deposit insurance, and its ability to stabilize markets, has fundamentally changed. Today, only a fraction of customers’ money — particularly business payrolls — is covered by FDIC insurance. With so much unprotected money moving to make businesses work and allow consumers to pay their bills, the risk of a run that can destabilize institutions and markets, particularly in the era of instant global communications, has naturally increased. It is time for Congress to return to the drawing board on how deposit insurance operates and is delivered.
Finally, regulation must be cooperative. Although we live in a remarkable, tech-enabled world, obsolete laws keep regulators firmly anchored in 20th-century technology that leaves them looking backward and fighting the last battle rather than the coming storm. It’s time for real-time regulation, supplemented by artificial intelligence techniques, that can focus on understanding what is coming, not what has just happened.
At the same time, technology should be used to help drive a new form of cooperative regulation where regulators and industry experts share knowledge rather than hoard it for their own purposes. Government overseers can’t oversee properly without the expertise that industry has. We should figure out how to deal with the conflicts and create more effective, forward-looking regulatory models.
These challenges are manageable if we acknowledge them and stop allowing partisan politics to dictate economic principles. That may be a lot to ask of the system these days, but it is the only way we can avoid the next financial storm on the horizon.
William M. Isaac, former chairman of the FDIC and Fifth Third Bancorp, is chairman of Secura-Isaac Group, a global consulting firm for financial institutions. Thomas P. Vartanian is executive director of the Financial Technology and Cybersecurity Center and author of “200 Years of American Financial Panics” and “The Unhackable Internet.”