The brief government shutdown exposes a significant flaw in America’s financial regulatory structure: the weakness of our market regulators. When the government shuts down, the two main watchdogs of our financial markets, the Securities and Exchange Commission (SEC) and the Commodities Futures Trading Commission (CFTC), shut down with it. This is in sharp contrast to bank regulators, like the Federal Reserve and the FDIC, who remain on the job protecting depositors and performing the key role of the central bank. Why the different treatment for two essential government functions in the modern economy? The answer shows even greater problems, including one of the failures of Dodd-Frank.
First the basics of regulatory structure. Congress established each of the financial regulators, usually in response to a specific financial crisis. Over the years, Congress realized that the job of financial regulation often involves politically unpopular decisions. Wisely, Congress structured most regulators as financially independent entities. This gives the regulators the freedom to take tough actions without worrying that some in Congress would try to sneak riders, small bits of legislative language that can restrict regulatory action, into annual funding bills.
The outcome has been a bank regulatory system that funds itself. The Federal Reserve, FDIC, Office of the Comptroller of the Currency (OCC), all fund themselves through various means, usually correlated to their core activities and often funded directly or indirectly through the financial institutions they regulate. This means that they are not dependent on Congressional funding (aka appropriations). Thus, when Congress fails to pass an appropriations bill and the government shuts down, the bank regulators keep right on working.
Congress retains ultimate control of all agencies, free to change the law at any time. Oversight is administered through Congressional hearings, the nomination and confirmation process, inspectors general, the Government Accountability Office, and importantly the press and the public. Just because an agency is ‘off-budget’ does not mean it is off the hook.
This logic behind the treatment of bank regulators applies equally to the SEC and CFTC who regulate financial markets. Regulating the stock, commodities, futures, and debt markets requires politically difficult choices. The agencies can fund themselves using small fees on the market participants who depend on their regulation to enjoy the benefits of our nation’s financial markets. In fact, the SEC has been imposing a small transactions tax on stocks for decades, which is more than enough to fund itself and the SEC, while keeping the fee at approximately two cents per thousand dollars traded.
The need for market regulation does not disappear when the federal government shuts down any more than the need for bank regulation disappears. However, a prolonged stalemate in Congress would result in the following at the SEC: “The Divisions of Corporation Finance, Investment Management, and Trading and Markets, and the Office of Compliance Inspections and Examinations will be unable to process filings, provide interpretive advice, issue no-action letters or conduct any other normal Division and Office activities. As a result, new or pending registration statements or applications for exemptive relief will not be processed regardless of the status of any review of those filings.” Further, the SEC’s enforcement division will “have only a limited number of staff on duty to perform critical functions.” Ongoing litigation, the SEC’s bread and butter of pursuing criminal wrongdoing will be discontinued in most instances, as will “pursuing the collection of any delinquent debts or work to distribute funds to harmed investors.” The cops will be off the beat.
The solution to this problem is simple: Congress should treat the SEC and CFTC as it does the bank regulators and allow them to fund themselves. This common sense solution has been advocated by past leaders of both agencies, the Bipartisan Policy Center, and the Systemic Risk Council. This would not cost taxpayers an extra dime, as the agencies already generate enough revenue to pay for themselves. Further, to the extent that agencies continually waste resources preparing and administering shut downs, giving the SEC and CFTC their own funding streams would eliminate wasted resources.
The government has now shut down twice since the last financial crisis. So far there has not been a major financial market calamity during those shut downs. But there is no reason to take this risk. Banks and financial markets stay open even when the federal government shuts down. So too should their regulators.