When the Fed dropped its Friday bombshell on Wells Fargo, initial reaction was transfixed by whether the Fed had gone far enough or too far with regard to sanctioning the company. This debate has important implications for embattled big-bank directors, but it misses a fundamental, structural policy change with far-reaching strategic impact. The Fed’s enforcement action establishes the source-of-strength doctrine as a rationale for over-arching Federal Reserve governance of a bank holding company, functional regulator be damned. If the Fed means what it said, still more banks will try to flee the BHC corral and those stuck in it will revive the Administration’s 2017 construct to liberate financial holding companies.

The Fed’s view is unsurprisingly consistent with the Fed’s own institutional interests. In it, a BHC is essentially a super-bank that warrants top-down regulation across the array of activities within insured-depository subsidiaries, their affiliates, and non-banking activities housed in the BHC or, when these tread into more non-traditional businesses, those in a financial holding company. The thinking here is that one cannot trust an insured depository institution (IDI) to keep its taxpayer-backed benefits to itself despite applicable law and the self-interested efforts of a primary regulator to enforce it. As a result, funding is allowed to flow relatively freely across the inter-affiliate transaction barriers, cross-selling prevails, operational leverage is achieved, and non-banking activities are governed by the Board under bank-like rules to ensure that the parent can support the IDI under stress. That is, the source-of-strength doctrine rationalizes all of the rules across all of the businesses that have nothing to do with banking. No wonder BHCs as a whole were once considered TBTF and orderly resolution now requires living wills from BHCs – not just big, lead banks.

This has been the way of the BHC world for so long that it’s easy to forget that there’s another vision of what a bank holding company is all about. As I told Congress some time ago, I like this one a whole lot better because it isolates taxpayer benefits far more tightly to the only place they belong: in the IDI. In this view of a BHC – the original one behind both the 1956 and 1970 laws creating BHCs as we know them – the BHC is a parent company that owns more than one bank and/or owns a bank or two along with a few other activities not permissible within an IDI. The BHC is the company’s face to shareholders and risk is to be lodged there, emphatically not in the IDI itself or down-streamed as a result of the IDI’s affiliation with other IDIs or non-banking activities in the BHC family. In this model, non-banking activities are not subsidized by the IDI or assumed to be protected from market discipline by sibling banks. As a result, both the parent company and all it does that isn’t banking are relatively free to meet the competition head-on.

With tight barriers between the BHC and subsidiary banks, BHCs are free at the parent company level to do pretty much as they like. This is in fact the way Congress allows the parent companies of non-bank banks to operate, an ironic twist that leads to the current situation in which BHC parents of full-service banks are slammed and non-traditional ones with highly-leveraged, untested parents can engage in the full range of commercial and financial services for which an IDI charter comes in mighty handy.

Both the current BHC approach of de facto Fed regulation across the length and breadth of a BHC and the hands-off approach for non-banks make no sense, exacerbating the regulatory asymmetry that creates risk pockets – sometimes big ones – outside the reach of federal regulators even as regulated companies spend all their time in the wringer. Consolidated BHC regulation should apply across the range of IDI parent companies and it should do little more than ensure sufficient strength under even acute stress to protect the IDI – not so easy if done really right.

Is this a windfall for really big BHCs? No – quite the reverse. Treating the BHC as a shell and regulating the IDI as a ring-fenced, rock-solid bank means that the Fed as BHC regulator would have to do far more than it ever did to prevent the BHC from plundering the subsidiary bank. It also means that all of the federal agencies would need to look at BHC and like-kind companies not with an eye first to their own jurisdiction and authority, but first and foremost to how risk moves in the enterprise and how best to ensure it lands in the lap of shareholders, not the FDIC.

Freeing the BHC and regulating the IDI in fact could prove awkward for many large, diversified BHCs because their internal leverage and economies of scale are posited on the consolidated model that has long, if wrongly, permitted the taxpayer-afforded benefits of a bank to flow with remarkable ease through the rest of the holding company. Consolidated regulation at the parent captures some of this benefit back from a safety-and-soundness perspective, but at far too much cost to market discipline and long-term competitiveness and innovation.

The Fed’s order against Wells Fargo of course has no such redesigned BHC in mind. Rather, its intent is to double-down the consolidated regulatory framework so that the Fed has a policy rationale on which to intercede regardless of what the OCC, CFPB, SEC, or any other regulator might tolerate. After the race to the bottom that characterized pre-crisis regulation and the occasional, opportunistic charter conversions the OCC has again begun to enable, the Fed’s assertion of authority may be understandable. It’s still wrong, though, and ultimately destructive of the only way to re-envision U.S. banks and their parent companies as innovative, successful, and still safe-and-sound competitors vis-a-vis platform companies and all the others ready to cherry-pick BHC franchise value into bits and pieces.