Reforms shouldn’t stop at Wall Street
The financial industry isn’t the only one that needs reform. The Federal Reserve, which if Senator Christopher Dodd has his way will get even more authority over the banking system, needs a transformation of its own. After all, the most senior U.S. financial watchdog missed one of the biggest credit bubbles since its founding.
But while action is called for, it’s not obvious what sort. After all, mindset, not the rulebook, was the Fed’s main weakness during the credit bubble. It had enough legal authority and political independence to fight against financial excess, but chose not to.
The politicians who are trying to redesign the national financial landscape can’t legislate a new intellectual paradigm, but they can try to avoid three pitfalls.
First, beware of the monolithic mindset. The 12 regional Federal Reserve Banks, each with its own traditions and expertise, provide a healthy check on groupthink in Washington and New York.
Second, don’t let politicians micro-meddle. The Fed needs political guidance on how to balance its objectives, but it’s healthy to have tension between a strong central bank favoring financial stability and elected office-holders primarily wanting happy voters.
Finally, beware of regulatory capture. As it stands, the two best-informed members of the board of the New York Fed are chief executives of giant financial companies: Jamie Dimon of JPMorgan and Jeffrey Immelt of General Electric. That creates unacceptable potential for conflicts of interest.
Mr. Dodd’s plan, unveiled on Monday, gets it mostly right. The regional Feds will stay, which is a plus. Bankers will be kicked off their boards. That’s good, but the plan goes too far by also banning all former bankers, whose expertise could be useful.
The plan goes wrong by making the New York Fed president a political appointment, just like the members of the Fed’s central board of governors. Politicians aren’t ideal judges of who has the technical expertise needed to sit at the center of the financial markets.
Still, one more political appointment might not be too high a price to pay for a generally sensible reworking.