One key provision in Sen. Dodd’s discussion draft would combine the bank supervisors into a single new agency. All of the regulators and much of the industry strongly oppose this idea, with advocates countering that the regulators are just protecting turf and banks like regulation the way it is because it’s been so easy. There’s truth to both assertions, but that doesn’t mean a single regulator is the solution. In our view, a single agency could be quickly captured and, left unchallenged, become an even more indolent supervisor than its predecessors. But, for many agencies to be better than one means that all of them have to do better than they did. The restructured banking agencies need to create a highest common denominator, not the lowest one seen all too often in the run-up to the crisis. If Congress keeps the banking agencies more or less as is – as it should – it should mandate a new, transparent inter-agency process.

Recognizing their credibility challenge, the banking agencies have – at least in public – put aside how much they heartily dislike each other and come together as a new mutual-defense organization. The only regulator out in the cold is OTS, as none of the other agencies wants to sacrifice scarce political capital to defend the thrift supervisor. As we’ve said before, it’s toast. But, as each of the remaining agencies defends itself, we’ve seen little to ensure a real, lasting commitment to tough decision-making. Much of the debate instead is based on assertions that one or another of the agencies blocked someone else’s proposal. Basel II is about the only example anyone can cite, though, because everything else was done – or mostly left undone – by consensus.

Case in point: the guidance on non-traditional (read, risky) mortgages. A senior official at the OCC spotted these mortgages as serious problems starting in 2002. It took years to get agencies to come together on a proposal in this area that was watered down a lot from the OCC’s initial idea and, even then, laid out as guidance – not a rule – to avoid offense. The proposal was then diluted still more – for example, the agencies decided not to sanction banks for originating risky loans if the loans were bundled into MBS and carted away. That decision, of course, protected banks at the expense of the global financial system.

Even with this concession, though, one agency (OTS, we think) demurred and the guidance continued to languish. It took Congress until the end of 2006 to call the regulators up for a hearing and embarrass them into issuing the final guidance. And, even then, it wasn’t enforced. Now, it’s moot because the mortgage crisis has – at least for the foreseeable future – forced the industry back to traditional loans.

Why didn’t the OCC proceed on its own? It feared that tough action would spur still more conversions to alternative charters. The agency was still licking its wounds from a decade earlier, when national banks turned to states in droves because they feared tough CRA regulation. More recently, the OCC saw Countrywide flee to the OTS when OCC tried to rein it in, and it knew of numerous other banks that could turn tail if things got tough on the mortgage front. Pending legislation would make it a lot harder for banks to find a comfier regulator, but arbitrage-driven charters can and will continue to occur unless the legislation goes further to ensure that multiple bank regulators combine for the better, not worse.

How to do this? First, Congress should re-evaluate statutory demands that the agencies issue inter-agency standards that are as uniform as possible. This was understandably done to limit arbitrage and control complexity, but it’s come to be read as a mandate that enforces compromise. When agencies differ, they can and should go out on their own. Only troubled banks should be blocked from a charter conversion so that banks can migrate to better regulation when, in fact, the rules are better reflections of market reality. And, when they aren’t, banks under other, tougher regulators will cry foul – in public. This would bring market discipline to rulemaking and, we think, considerably improve it without creating the type of bottom-fishing regulation we’ve seen to date.

Congress should also mandate a process in which dissenting regulators make known their views so that public policy broadly can evaluate differences and decide on its own when a lone agency is in fact fighting a good fight that warrants back-up. When proposals simply languish for years as agencies bicker, emerging crises go unaddressed – again, as we now know all too well.

The agencies don’t vary their rules so much that new safe harbors for bad practice occur. And, of course, the toughest idea isn’t always the best – the process has to ensure that dissent from the industry is heard and reflected as appropriate.