FDIC Chair Sheila Bair made a very interesting point in her speech to bankers in Orlando earlier this month when she noted that extensive consumer protection laws applied to the banking industry spawned the shadow banking sector. She noted that the buttoned-down practices of traditional banks allowed no room for questionable practices, so those questionable practices emerged outside the ranks of traditional banking.
“The regulatory reforms put in place after the last crisis actually helped push risk-taking outside of traditional banking and into the shadow banking system,” she said. “This created gaps between regulatory jurisdictions; weakened consumer protection; and led to the problems with subprime and nontraditional mortgages, and risky securitization structures.”
Bair then goes on to make the case that increased consumer protections should not be focused on the traditional banking sector, but on the shadow sector. Here is what she said:
But it’s time we leveled the playing field for all market players. We need strong rules that apply — and that are enforced — across the board for banks and nonbanks. And it is just as important to ensure that the burden of this regulation does not fall on the mainstream lenders who were not the cause of the problem.
The bankers welcomed this message. But I think it is worth considering whether this problem can ever be solved. When lawmakers passed tougher consumer protection laws and applied them to banks, they thought they were applying the law to all the relevant parties. They didn’t think they were leaving anyone out. Well, since the laws were passed, new industry sectors emerged to get around the laws. Is this cycle breakable? If new, broader laws are passed this time around, what is to stop the emergence of still more niche sectors?
It will be a daunting task to come up with an examination and enforcement regime for non-banks sufficient to match the level of supervision currently applied to banks. Keep in mind that the non-bank sector is much larger than the bank sector. My point is, even if you accomplish this herculean task, new kinds of businesses that skirt the rules are likely to emerge. It is a vicious cycle.
I am not saying government shouldn’t try to protect consumers, but I suspect there will always be weak spots. Universal oversight that prevents all companies from offering any products that could be deemed questionable simply seems impossible to me.