Inside the Factions of Financial Regulators

America is in the middle of a Washington turf war. And that could be good for ordinary citizens and the global financial system. The war started when failed Washington financial watchdogs woke up to the realization that they might actually lose power or even, shut down. The territory they are supposed to regulate was getting snatched away.  Nails sharpened and teeth bared, they moved in for a fight.
 
Serious charges of civil fraud brought against Goldman Sachs by the U.S. Securities and Exchange Commission on April 16 was an opening turf shot. Even though Goldman had evidence nine months earlier that the government was investigating its role in deliberately creating toxic debt for gain, the surprise announcement of the charges was a shock.
 
Less dramatic but just as determined to hold onto its turf is the U.S. Federal Reserve System. Two days before the Goldman indictment, five top officials of the U.S. Federal Reserve System, four bank presidents and one board member showed up at an obscure New York conference to break bread with Fed critics who are angry about the Fed's failure to rein in big Wall Street banks. You'd expect the Fed officials to have been happy because Washington lawmakers are now giving them direct orders to concentrate on regulating the 20 largest banks in the country.
 
To do that, the Fed would give up regulation over thousands of smaller U.S. banks which didn't cause the subprime crisis but in many parts of the country are failing because of it.

Most people would say, "So what?"

But to Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, the regulatory loss would "rip the heart out of the Fed." Hoenig argues that watching smaller banks tells you what is really going on in the economy and provides intelligence on what the big banks are up to. Whether he's right or wrong, Hoenig has started a fight that says the Fed wants to show the public it can get tough. "This is not a turf war," says Hoenig. Which means, it is.

But that could be OK. "The Goldman indictment said wow, the SEC has a pulse," said Bert Ely, a long-time Washington regulatory consultant. The unprecedented arrival of the five Fed officials pleading for their turf could also be good, he says. If one regulator gets aggressive, others will try to out compete to hold onto their power and funding. Besides Hoenig, Fed bank presidents from Dallas, St. Louis, Cleveland and the Fed Board in Washington made the same plea – don't shrink our regulatory turf.
 
Ordinarily, infighting among Washington bureaucrats shouldn't concern the rest of the world any more than a battle among tax regulators in Beijing would interest Americans. But sometimes a dust-up carries a hidden message. Among regulators who get the most blame for failing to stop overcharged lending and toxic mortgage sales is the New York Fed and its former President, now Treasury Secretary Timothy Geithner. It probably wasn't an accident that New York Fed officials weren't at a meeting a short cab ride away.
 
Instead, the central bankers who worked the meeting like Hoenig and Richard Fisher of the Dallas Fed are in a camp that wants to downsize the big Wall Street banks to US$ 100 billion in assets – a size they say would make them manageable enough to close down and end the hated "too big to fail" massive bailouts of last year. That's called cutting into New York Fed turf.

In a strange way, the battle over what's the safe size for a bank and what happens to a regulator's turf are crossing paths. Meanwhile, Wall Street will be kept wondering if there's another Goldman-like bomb ticking. Stay tuned.
 
Robert Dowling is the former managing editor of Business Week International.