Sunday, 13 September 2009

5 Reasons NOT to Make the Fed the Systemic Risk Regulator

I realize this debate peaked about three or four months ago, but wanted to get my two cents in. Originally I waffled on whether the Fed should take on this role. Absent compelling evidence, I waffle no more. I'm not in favor of having the Fed -- the powerful central bank the U.S. created almost 100 years ago -- regulate systemic risk in our financial system. This is why:

1. The Fed's independence -- standing on high ground, removed from the ebb and flow of political currents -- is more liability than asset. My thinking here is straightforward: no body composed of any number of wise men will successfully manage all threats of systemic risk. However, when the designated risk regulator does egregiously and clearly screw up, I think there should be clear, well-defined lines of accountability.

2. The Fed is too opaque. Watching the disclosure battle between the Fed and Bloomberg News makes me more than a little nervous. The Fed doesn't want to reveal the companies taking part in its emergency lending program, as well as how much these companies have borrowed and what collateral they have put up. This bothers me a lot, because this is a multi-trillion dollar program, operating in the dark, and the U.S. taxpayer is clearly on the hook if the Fed's bets go bad. Perhaps in the heat of a crisis you can make the argument for secrecy. A full year after the Lehman bankruptcy, that argument no longer holds water. We need regulators committed to transparency.

3. The Fed doesn't have the regulatory chops. The Fed just hasn't shown itself to be much of a regulator, period, over the decades. That's simply not what it does very well. Just look at and listen to Bernanke. He has the manner of an economist you'd find toiling wonkishly in a backroom at the World Bank. If you're unconvinced of my point, check out the latest: Fed Failed to Curb Flawed Bank Lending, Inspector General Says.

4. The Fed was wrong about this current crisis. This is far from an original point, but bears repeating. That's because Alan Greenspan was the closest thing we had to a systemic risk regulator in the runup to the credit meltdown. The most casual-seeming of utterances that fell from his lips had the power to throw markets into convulsions. He could have done more to deflate the housing bubble than an army of rank-and-file regulators by just expressing concerns about what was going on. But the fact remains he didn't see anything wrong.

5. For symbolic and functional reasons, we need fresh ways forward. I'll make reference again to the recent internal report on how the SEC botched the Bernie Madoff investigation: There is a seriously deep level of rot in our regulatory institutions. It's incompetence of such a staggering dimension that outright corruption almost seems preferable. In the face of that, I think that we need to try an entirely new way forward for regulating broad risks to our financial system.

So what do we do? I think that the Fed should be a strong voice at the table when it comes to identifying systemic risks. But I think we need many, many voices at the table. In the end, we also need an agency that will operate with something rare in this crisis -- transparency. And we need someone with the moxie of an Elizabeth Warren at its helm, not another lapdog for the financial services industry.