The pursuit of additional regulatory power by the political appointees currently running the Federal Deposit Insurance Corporation (FDIC) over large index funds is the latest example of a bureaucracy more preoccupied with internecine turf battles than actually doing its job. A recent Notice of Proposed Rulemaking initiated by its staff to give it additional oversight authority over investment managers who already have enough oversight is a solution in search of a problem.
The Change in Bank Control Act requires any entity owning more than ten percent of the outstanding stock to obtain approval before reaching this threshold and pass certain tests to ensure it does not exert undue influence and possibly enrich itself at the expense of the other shareholders. While several index funds have exceeded this threshold, passive investors have a waiver from this requirement, since their investment holdings in the bank are based on their need to replicate a stock market index and they do not overtly exert any pressure over the companies they invest in (except for encouraging them to pursue environmentally and socially responsible actions).
However, the current FDIC management would like to end this exemption, and impose a test on index funds to ensure they do not exert undue influence on banks or try to place directors directly on the board. The rule would give the FDIC more power to police index-fund managers and their stakes in American banks. FDIC director Jonathan McKernan recently took to social media to make his case that the FDIC should more closely scrutinize big index-fund managers’ stakes in U.S. banks.
However, the rationale for extending the FDIC’s regulatory tentacles to cover index funds smacks of regulatory overreach from an entity that cannot deal with its current regulatory tasks, let alone add new ones.
The last 18 months haven’t been good for the FDIC. For starters, its team was asleep at the switch (along with the Federal Reserve Bank of San Francisco) when the Silicon Valley Bank went under after having made bad bets on Treasury bills that should have been easy to avoid--or for a regulator to have prevented. Its collapse took a few other banks with it, and for a long two weeks every single bank in America with a significant proportion of deposits over the federal deposit insurance limit was in full panic mode. Three of the four biggest bank failures in the history of the U.S. have occurred within the last 18 months.
We have also learned the longtime head of the FDIC, Martin Gruenberg, has been overseeing an agency where sexual harassment is endemic and the 500 or so women who dared to report it during his tenure often faced retaliation from their supervisors. A report on the corporation’s problems found that Gruenberg’s hair-trigger temper meant no one wanted to bring problems to him and as a result, they tended to fester--so regulatory lapses and reprehensible behavior in the agency often went uncorrected.
While Gruenberg would have been fired--or prosecuted--if he were a Republican, he inexplicably remains on the job. Elizabeth Warren has apparently choked back her reflexive moral indignation because it would be politically inconvenient for her if he were to depart.
Normally, a regulator that has proven itself unable to do the tasks assigned to it by Congress or even protect its own female employees from predation would concentrate on reforming its own operations. A regulatory agency that has spectacularly shown it cannot accomplish the tasks assigned to it by Congress has no business making a move to hone in on another regulator's portfolio. It’s telling that the NPRM suggests that the Federal Reserve’s regulatory actions are insufficient in this regard are one reason for it to insert itself into this matter. If there’s one thing the FDIC leadership should not be doing--besides trying to expand its regulatory authority--it would be to cast aspersions towards one of its regulatory rivals.
Index funds have grown exponentially in the last two decades and for a good reason: For most Americans these represent the most sensible way to invest. Making it more difficult for such funds to invest in banks and imposing a new set of regulations upon them--to be administered by a failed agency--would be bad policy.
