Thrifts Like WaMu Could Suffer Under New Treasury Plan

My initial take on the Bush Administration’s proposal to overhaul regulation of the financial services industry is that the plan appears to be an intelligent, measured response. The existing regulatory system was set up when banks were both the main creators of credit and bearers of credit risk. Years of financial innovation have made that model obsolete. It’s reasonable that the system’s regulatory structure keep up with changes that have occurred in the industry.

To begin with, if the Federal Reserve is going to get into the habit of bailing out securities dealers, it should have the right to oversee their financial strength.

And, yes, the Office of Thrift Supervision has perhaps outlived its usefulness and no longer needs to exist. The thrift industry it was set up to oversee has morphed beyond all recognition.

So who might the biggest losers be if the Bush plan is put in place?

For starters, thrifts who’ve dressed themselves up to look like banks, such as WaMu (WM). These institutions have benefited for years from the OTS’s relatively loose regulation; they could face serious risk should they fall under the watch of the Office of the Comptroller of the Currency and thus face the same scrutiny as commercial banks. Some institutions perhaps wouldn’t survive the twin pressures of the current environment and tighter OCC regulation.

In my view, however, the OTS’s regulatory approach is often enlightened, and should be copied by other bank regulators.

Too often, bank regulators are heavy-handed and overly intrusive in the everyday running of a bank. For example, why does the OCC insist on approving every single new bank branch? The policy makes no regulatory sense, contributes nothing to the system’s safety and soundness, and is costly and time-consuming to administer. European regulators don’t have such a rule. And yet the approval requirement gives the OCC a potent weapon it can use to essentially make up and enforce any rules it wants. That resulting arbitrary and capricious regulatory environment helps neither banks, nor borrowers, nor depositors.

Similarly (and as I’ve discussed before) the current rules on banks’ ability to raise capital should be overhauled, as well. In particular, the current system’s overly severe definition of what constitutes a “control position” drastically limits the ability of private, non-bank institutional investors to supply capital to the banking industry. The OTS, by contrast, defines “control” as an ownership stake as a position of 25% or more of the institution. That’s a much more enlightened and real-world view. If it applied to banks broadly, they’d have a much easier time raising the capital they need.

The credit crunch hasn’t offered much in the way of silver linings. But one possible positive it’s created is a real opportunity to improve a regulatory structure that has some real flaws. The Bush administration’s proposal is a good starting point for replacing old, outdated, and stupid regulations with new and improved rules.