The Fed’s New Powers

The proposed reform of the banking sector is very large and multi-faceted, and will be the subject of many blog posts over then next few months.

However, at yesterday’s congressional hearings the topic that drew the most fire was the idea of making the Fed the “systemic risk regulator.” Clearly there is a need for such a regulator, so in my mind, doing nothing would be the worst possible option.

Then again, is putting the Fed in charge the right answer? As I see it there are four possible answers.

• 1) Put the Fed in charge
• 2) Form a new agency with those powers
• 3) Give those powers to another existing agency, for example the FDIC or the Comptroller of the Currency
• Have a committee of regulators do the job

As Sen. Chris Dodd put it, giving these powers to the Fed is like buying your son a new faster and more powerful car as a reward after he just crashed the family station wagon.  Let’s face it, the Fed did not exactly cover itself with glory in its existing regulatory role leading up to this crisis.

There were several steps the Fed could have taken to have prevented the crisis or at least greatly minimized its impact.  Not all of them require remarkable 20/20 hindsight.

On the other hand, the Fed does have considerable expertise in these matters, and proper supervision of banks is closely tied to monetary policy. The Fed already has some expertise in dealing with non-commercial banks — for example the investment banks that are also primary dealers in government securities, such as Goldman Sachs (GS) and Morgan Stanley (MS). As both a plus and a minus, of all the regulatory agencies the Fed is the most independent and the least susceptible to political interference (and oversight).

Forming a new agency would take time to get it up and running, and would probably lead to turf battles between it and the existing and remaining bank supervisory role of the Fed. A reasonable case could be made for putting the FDIC in charge, and in the post mortem of the crisis, the FDIC will probably be regarded as the regulator that did the best job (talk aboutdamning with feint praise).

However, the systemic risk regulator will have to deal with financial institutions that are not depository institutions, like banks or thrifts. The FDIC has no particular experience or expertise in dealing with them — ditto for the Comptroller of the Currency. And the FDIC sort of has its hands full at the moment as it is.

Leaving it to a committee would simply defuse responsibility and accountability, and aside from doing nothing is the least appealing option.

Thus, I do come down on the side of giving the job to the Fed (but could be persuaded to give the job the FDIC). However, I would like to see it accompanied by several major changes at the Fed. The Fed is currently owned by the banks, (literally, not just figuratively) and they get to pick the regional presidents and make up the boards of directors.

This is an obvious conflict of interest. As part of the reform, the regional presidents should be appointed by the President and confirmed by the Senate. The term in office could be set so it is different from the presidential cycle.

The boards should include non-bank directors. There is also a bill moving through Congress to audit the Fed. This should be passed and the audits done, and released in an annual report to the public (and Congress).

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