The Corporatist Foundations of Financial Regulation

Nobody should feel sorry for banks, necessarily, but they labor under heavy, and in almost every important way, unchecked, regulation. The prosperity of banks challenges some of the basic assumptions of American administrative law—that transparency and process create better regulation through sunlight and reasoned decision-making, that judicial review checks regulatory abuses where sunlight and reasoned decision-making do not, and that a utilitarian assessment of the merits of regulation is essential. The banking regulatory regime features none of these regulatory basics.

• Financial regulatory agencies do not rely on appropriations by Congress; rather, their budgets are generated by the fees they impose on banks, and in the case of the Federal Reserve System, profits that come from buying and selling government debt. This makes financial regulators legislatively unaccountable, and also reduces the executive influence of the White House, which negotiates with Congress on the rest of the budget.
• Bank regulators are also free from presidential control. Financial rules are not reviewed by the White House before being promulgated, as is the case for most of the rest of government. The President cannot remove appointees whose policymaking she disapproves of in most cases, reducing oversight by the executive branch.

• Banks rarely, if ever, litigate to undo rules imposed upon the industry or challenge enforcement actions levied on any particular bank. Many think the reason for this reluctance to sue their supervisors is based on fear that the supervisor will retaliate against the bank. Apart from sounding arbitrary in its own right, this means that the third of the three branches of government has essentially been cut out of participation in our system of financial regulation.
• The enforcement actions of financial regulators are often not publicized; banking regulators insist that the public will panic if they cannot keep their disciplinary measures secret. Financial regulation is therefore not transparent, and if, as Louis Brandeis said, “[s]unlight is . . . the best of disinfectants,” the lack of transparency could mask abuses.
• Banks are subject to rules set through an international process that makes domestic notice and comment requirements superfluous, at least in part, and makes it difficult for banks to monitor international policymaking, which is a strike against the role of public participation in setting standards.
• Banking regulation is done without the cost-benefit protections afforded to other industries. While the application of cost-benefit analysis to banking would not make a lot of sense, the application of this constraint, since the Reagan administration, has served as both a serious hurdle for regulators inclined to promulgate new rules and a different mechanism for executive branch control of administrative agencies. And yet, banks cannot take advantage of it.

In 1966, Kenneth Culp Davis, a giant of midcentury administrative law scholarship, characterized banking regulators as applying a form of “secret law.” Banking regulators were operating on the basis of “secret evidence” in their decision making, failing to offer findings to support the decisions made, or issuing reasoned opinions, as required by the Administrative Procedure Act (“APA”). He considered banking regulation to be broken; it does not appear that the passage of time has changed much.

There are functional reasons for regulators to enjoy such broad discretion when it comes to banks. Banking is a dangerous business, and there is a case to be made that regulators need to have the power to swoop in to prevent financial crises, which can arise within minutes, without fear of pushback by Congress, the President, the courts, or the public.

But there is more to be learned from the banking paradigm than that banking is weirdly dangerous and is accordingly regulated weirdly. We can make sense of this sort of governance by understanding it as the foremost exemplar of collaborative administration in the modern American state. Modern administration offers distributive regulatory arenas and integrative regulatory arenas. In the distributive arenas, regulation is zero sum—regulators, regulated industry, and other interest groups must compete over whether the country or the industry must bear the costs of a regulatory regime. Environmental protection and workplace safety regimes are examples of distributive regulatory schemes. In these contexts, traditional administrative law, where courts police regulators from overreaching, double-check the science (or at least the process for identifying and applying scientific insights), and insist that regulation is subjected to ventilation through comment and a cost-benefit assessment, makes sense. Throughout the rulemaking process, industry groups and their opponents watch the regulators like hawks, weigh in with their own studies, and put the regulators through their paces.

But in areas where industry and government have mutual interests—an integrative context—regulatory constraints are less important than the partnership between public and private. Financial regulation exemplifies this partnership. In addition, although the question is somewhat more fraught, banks and the government have a shared interest in a resilient financial system that can make it through a crisis. Because banks and the government share some of the objectives involved in both the normal provision of banking services and financial crisis management, banks and government have a different sort of relationship than do polluters with environmental regulators, and employers with workplace safety regulators.

Although it is often ignored in administrative law scholarship, this phenomenon does not only apply to banking. Similar outcomes might particularly be the case for “public goods” sectors of the economy. These kinds of sectors are those in which the public interest in the provision of services—in the case of banking, the service provided is the extension of credit to businesses and individuals—is high, meaning that government oversight of the sector will look more collaborative than conflictual.

However, the benefits of collaboration come at the cost of public legitimacy. Banks are disliked, and collaboration with the government can look awfully like regulatory capture. Banks would be more popular under a more transparent regulatory regime, where the precise nature of the collaboration, and the moments of adversarial separation between banks and government, are more obvious to all who wish to look. To achieve greater transparency in a collaborative model, banks should sue the government more, the government should make public more of its dealings with banks, and the international aspects of banking regulation should continue to embrace more and more transparency.