By Wyatt DuBois, Penn State
UNIVERSITY PARK – It’s been said that law and sausage are two things you don’t want to see being made. But Smeal College of Business professor John Liechty would beg to differ—at least regarding law. For over a year, Liechty had better than a front-row seat in legislating as he worked with Congress to create a new federal agency, which he devised, with the ability to monitor the entire U.S. financial system for risk. He says he found the whole experience to be one of the highlights of his career.
When President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act, Liechty’s 18 months of research, conference calls, and Capitol Hill meetings finally paid off. Included in the massive financial reform law is the establishment of the Office of Financial Research, a new federal oversight agency that grew out of an idea that hit Liechty during a February 2009 conference on financial risk.
Liechty and other academics joined Washington regulators for a workshop on financial data and the federal rules governing how that data is used to oversee banks and other major financial players. Liechty, a professor of marketing and statistics at Smeal with experience examining financial data for major banks, realized that there was no agency looking at the big picture and the connections between financial institutions. There are several federal agencies regulating various sectors of the U.S. financial system — from the Securities and Exchange Commission to the much-maligned Office of Thrift Supervision — but they don’t work together to monitor the entire system. They don’t often share data, and in some cases don’t have the authority to collect the data needed to identify the kind of risk that could cause another financial collapse.
“Imagine an auto race,” Liechty said, “where each driver has a team to make sure that his car is operating safely, but there is no one watching the entire race for road conditions, overall speed, how the cars are bunching together, and other factors that will affect the entire race. It’s crazy. And it’s dangerous.”
So, on the second day of the conference, when the participants broke up into small groups to write academic white papers on possible research projects, Liechty joined Mark Reesor of the University of Ontario and economist Mark Flood to write a policy paper calling for what they termed the National Institute of Finance. The three soon recruited Penn State economist Arthur Small and Allan Mendelowitz, former director of the Federal Housing Finance Board, to join the movement.
Mendelowitz’s Washington contacts helped the team get meetings with officials at the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, and the Board of Governors of the Federal Reserve system. A Penn State connection helped get them in the door at the SEC where they pitched SEC chair Mary Schapiro, and connections from within the finance industry helped arrange a meeting with Deputy Treasury Secretary Neil Wolin. Each connection they made led to another.
At the same time, Liechty and his colleagues were gaining momentum in academia and corporate America at conferences, through social media, and by old-fashioned word of mouth. There was the IT expert at Morgan Stanley who was already thinking about these issues. There was the engineer at IBM who had the technical know-how to build the technology needed to collect the data. And there was a group of Nobel Laureates—six of them—who came together to endorse the formation of the OFR.
The team’s weekly conference calls grew from five people to more than 40. They organized under the banner of the Committee to Establish the National Institute of Finance, a group with more than 130 members — 60 of whom could list their names publicly — by the time they realized their goal.
Liechty and his colleagues worked with Sen. Jack Reed’s staff to craft the legislation and insert it into Sen. Christopher Dodd’s financial reform bill. They got bipartisan support after a meeting with Republican Sen. Bob Corker and Democratic Sen. Mark Warner. Their 20-minute meeting with Corker and Warner ran 65 minutes long, and by the end, they were both believers.
It turned out that there were very few opponents to creating the OFR. One was Karl Rove, who wrote a column in The Wall Street Journal using terms like “Big Brother” and warning that the agency would devolve into a bureaucratic behemoth collecting the personal financial information of everyday Americans. Not true, said Liechty, and besides, he pointed out that the USA PATRIOT Act, which was passed with Rove in the White House, already allows such data collection by intelligence agencies.
Meanwhile, the seemingly obvious opponents — Wall Street banks — were too busy looking at other pieces of the financial reform bill to pay much attention to this part of it. And those that did get wind of it were quickly swayed into supporting it. While the banks and other financial institutions will bear the cost of the OFR, by standardizing the data they’re already collecting, they will actually save money in the long run, according to Liechty.
He calls the establishment of the OFR a win for all parties. It gives the government a new tool to help prevent another collapse, protects taxpayers from costly bailouts, and allows the financial industry to standardize and streamline its data collection. Best of all, Liechty says, it ensures a more stable economy in the future.
The Treasury Department is now in the process of building the OFR, including the IT infrastructure necessary to securely collect and analyze the immense amount of data needed to prevent a financial collapse. This massive undertaking, called an economic Manhattan Project, is on a tight deadline. The OFR is scheduled to give its first report to Congress in two years.