The last days of the Office of Thrift Supervision (and of the theory of regulatory competition?)

The top West Coast regulator of the Office of Thrift Supervision has been removed from his job while the Treasury Department's inspector general looks into some weirdness surrounding backdated capital infusions into since-failed thrift IndyMac. Add that to the demise of the biggest savings institution regulated by OTS, Washington Mutual, the loan troubles inherited from OTS-regulated Golden West Financial that forced Wachovia into a merger with Wells Fargo, and the various shenanigans associated with OTS-regulated Countrywide Financial, and things really aren't looking good for the agency. Oh, and don't forget AIG, which due to a quirk in our country's deeply quirky regulatory setup was also overseen at the holding company level by OTS.

The OTS was created as a semi-autonomous division of the Treasury Department 1989, to take over the regulatory duties of the Federal Home Loan Bank Board, which was seen as identifying too closely with the savings and loan industry to do a good job of supervising it. I was the OTS beat writer for American Banker in the mid-1990s, and in those days the agency was trying hard to be professional and just as tough as the other banking regulators. But there was still lots of talk of looking out for the interests of the thrift industry, and ensuring the attractiveness of the federal savings bank charter that OTS oversaw.

That's just the natural tendency of any specialized industry regulator, and I'm certainly not going to blame OTS for our current troubles. The craziest of crazy mortgage lending was done by mortgage brokers selling to Wall Street. The OTS-regulated thrifts mostly just followed in their lead. But OTS didn't stop them, I imagine, because people there were worried about thrifts losing market share. That, and they had been drinking the same home-prices-never-go-down Koolaid as everyone else in real estate. The regulators were of the industry, not above it.

This country's Balkanized financial regulatory structure (just for banks and savings institutions there's the OTS, the OCC, the FDIC, the Federal Reserve, and all the state banking commissioners) is mostly the product of history and bureaucratic turf wars. But for the past few decades there's also been a theory—regulatory competition, it's called—to back it up.

Having different state and federal entities compete for the privilege to regulate a particular company results in more market-friendly regulations, the thinking goes. That may be true, but more market-friendly regulations are also generally weaker regulations, and in the financial sector weak regulations can eventually end up destroying the very markets they're being friendly to. As we've seen lately.

I'm betting the theory of regulatory competition is going to go on holiday for a few years, maybe decades. The OTS will be among the first victims of the new intellectual climate—Hank Paulson already proposed getting rid of it last spring. Any guesses as to who's next after that?