Sheila Bair's 4 Types of Dysfunctional Regulators

There's still plenty of blame to go around when assessing the causes – and continuing after-effects – of the financial crisis, according to Sheila Bair, the former FDIC chair who keynoted this week's SAP Financial Services Forum in New York. And although Bair's harshest criticisms were targeted at banks and lenders that double-talked the regulatory agencies and put their own profits ahead of the financial safety of the public, she did not spare the regulators either.

Bair, who has been in the news recently talking up her new book "Bull by the Horns: Fighting to Save Main Street from Wall Street and Wall Street from Itself," argued that regulatory timidity and inertia has contributed to regulatory complexity and confusion. "The pace of Dodd-Frank implementation has been too slow," she said. "The regulators have left themselves open to litigation, they have not moved as aggressively as they should have. When the rules have come out they have been too complex. The rules lack clarity, and the public doesn't understand what is the real benefit."

[Is compliance a necessary evil or the foundation of strong and consistent performance? Read Compliance Doesn't Have to Be Painful for Banks]

Bair then outlined four categories or "groups of mindsets" into which she thinks too many regulators fall. She described the first as "rubber band regulatory, folks who were way too lax during the crisis, [thinking] industry can self-correct. That proved not to be the case. Now these folks, who were laissez faire, now [argue], 'We have to watch everything.'" She pointed to the current approach to mortgage lending standards is an example of the rubber band mindset. After years of taking a hands-off approach, "now they are trying to anticipate every possible thing that could go wrong."

The second category identified by Bair is "genius regulators -- sometimes too smart for their own good. They tend to write complex rules that no one can understand." The third group is "unbelievers, the closet free market people. They still don't think regulation will work," Bair said, adding, "They think the 2008 crisis was a 100-year flood." She made it clear she doesn't think there is any place for this philosophy in the regulatory world, declaring, "If you don't believe in regulation, you shouldn't work for a regulator!"

The fourth and "most problematic" type of regulator described by Bair are "captive" regulators -- those who move back and forth between jobs as regulators and positions with the companies they were charged with regulating. "There is not enough separation between their job -- which is to protect public -- and the industry." She argued this is a particular challenge with "safety and soundness" regulators, who are charged with making sure banks are profitable. "Banks must be profitable, but in ways that are safe and sustainable!" she stated. "There's a difference between what helps the broader economy and what helps the bank." While Bair thinks that the mandated stress tests will be helpful in addressing this problem, she said there "is still a long way to go. There needs to be better separation between regulators and the industry they regulate."

To that end, Bair would like to see an official end to the "revolving door," noting that the increasingly common pattern of regulators moving to the private sector (and sometime back) "does even influence the best of people." She thinks there should be "a lifetime ban on working for someone you once regulated … bad apples wouldn't want to be examiners if there was lifetime ban." At the same time, Bair said, the profession of bank examiner or regulator should be something that could be a "lifetime calling … something that top quality people aspire to."

She also argued that the banking industry benefits from a stronger, more independent regulatory environment. The current "push back on everything" approach actually works against banks' self-interest, she says. "It's very short sighted," Bair declared. "If you are going to restore confidence in the financial industry, the public has to have trust in the regulators, too. If they think you have weak or captive regulators, I don't think that helps anybody. [Bankers] need to better engage with what is going on in Washington, it's in your long term business interest to get this done."

[For more insights into the bank/customer credibility gap, see Banks in Danger From Dissatisfied Customers.]

Regulator liability isn't the only topic about which Bair expressed strong opinions at the SAP Financial Services Forum. Here are some of her other choice comments about the state of the financial services industry:

On Basel II and flaws in its model-driven approach to determining risk-based capital: "I do think higher capital requirements are a competitive strength."

On the bailouts: "They treated everyone the same, and not everyone was the same. Not all banks were part of the problem -- some of them were part of the solution. We painted everybody with same brush. What kind of signal … does it send to good managers, when everyone is treated the same? Why should they help clean up a party they never attended where the drunks are sent home in limos instead of to jail?"

On Congress: "Congress has to have some responsibility here. In the past Congress has been good on oversight over regulations, but there are other instances where Congress really hurt [it]. In … financial services there is a particular problem [where] campaign money infiltrates oversight and it's a source of jobs. I wish Congress would consider more restrictions. In recent years, I think Congress unfortunately has been part of the problem, not the solution."

On regulation in general: "Complex rules are easy to game, simple rules are harder to game."

Katherine Burger is Editorial Director of Bank Systems & Technology and Insurance & Technology, members of UBM TechWeb's InformationWeek Financial Services. She assumed leadership of Bank Systems & Technology in 2003 and of Insurance & Technology in 1991. In addition to ... View Full Bio