Today, the Administration is sharing its vision for the future of the financial system. To us, it seems more like a job creation program for Lawrence Summers, the Director of the White House's National Economic Council. It's long been rumored that he wants the top job at the Federal Reserve (Fed) should Fed Chief Bernanke's term not be renewed in early 2010. Summers, a former Treasury Secretary, and known for his hands-on, at times confrontational approach, seems an odd fit for what is traditionally a job for calmer spirits. The proposed overhaul of the financial system sheds light on this: the Fed may be converted into the nation's top regulator. Naturally, it will then require someone with executive experience; a prerequisite Lawrence fulfills well and who other than Lawrence Summers should be taking this job? We respect Mr. Summers, but should the most important reform of the financial system in 80 years be designed around one person?
We are most concerned that reform efforts are shooting in the wrong direction. Most notably, we are concerned about the independence of the Fed. Traditionally, while the Fed has an important regulatory function, it is primarily concerned with its dual mandate of price stability and maximum sustainable growth. It traditionally fulfills this function through monetary policy, influencing things like money supply, interest rates, and the cost and availability of credit.
As part of the financial crisis, the Fed has veered into fiscal policy, providing credit to specific sectors of the economy; Bernanke calls these activities credit easing. By providing specific funding for mortgages, credit card portfolios and car loans, amongst others, the Fed is deciding on issues that should be decided by Congress. The Fed has already shown how it completely underestimates the political repercussions of engaging in such programs, practically with no oversight. Congress has started to ask tough questions. These questions are likely to intensify and, in our view, will undermine the credibility and effectiveness of the Fed. For the Fed, the appropriate way to avoid the political minefield is to stay out of fiscal policy.
The Fed was never set up to deal with as many programs as it is engaged in right now. Possibly, the fact that the Fed lost members (banks) in recent decades as these moved to national charters subject to regulation by the Office of Thrift Supervision, may have played a role in the Fed's willingness to introduce programs to increase its influence over financial institutions. The proposed reforms will rectify that temptation as the Office of Thrift Supervision may be dissolved.
The proposed reforms are turning the Fed into a regulatory conglomerate. Without a doubt, the Fed would then be faced with many politically sensitive decisions. The Fed is setting itself up for failure; the day will come that its decisions will be questioned.
We welcome a consolidation of regulatory oversight. If policy makers want to move more power to the Fed, then come up with a structure similar to how FINRA and the SEC are structured. FINRA, the regulator for brokers, is a self-regulatory organization that reports to the SEC. Make FINRA report to the Fed if you wish to tighten the communication channels. Then you don't need to create another monster infrastructure, topped off by the additional proposed counsel to coordinate amongst agencies that is to be created; look no further than the Department of Homeland Security to see what happens when bureaucracies are blown up with the best of intentions.
There have certainly been regulatory shortfalls in recent years. However, it is doubtful that they will be addressed by piling on additional regulatory bodies and further eroding the independence of the Fed further. Some of the reform proposals are extremely helpful, such as moving derivatives onto regulated exchanges. The main problem in this and just about any financial crisis in history has been that too much credit has been available. Let's focus reform efforts on how to ensure that the availability of credit does not cause systemic risk. Taking the opposite approach, to limit systemically important financial institutions from engaging in certain businesses leads to conflicts of interest, possible corruption and endangers the competitiveness of U.S. financial institutions.
