Let the Fed regulate

November 20, 2009

By John M. Berry

John M. Berry, who has covered the economy for four decades for the Washington Post and other publications, is a guest columnist.

Politics is trumping common sense in Congress as Republicans and Democrats keep heaping abuse on the Federal Reserve. As a result, they could end up adopting an unworkable, risky overhaul of financial market regulation. 

Senator Christopher Dodd of Connecticut, chairman of the Senate Banking Committee, is leading the parade with his plan to strip the central bank of virtually all its oversight of commercial banks.

  “I really want the Federal Reserve to get back to its core enterprises,” Dodd said. In recent years, the Fed’s regulation of bank holding companies and consumer lending “was an abysmal failure,” he charged. 
No, the Fed didn’t cover itself with glory in some of its regulation and supervision, but neither did any of the other financial regulatory agencies. Moreover, the most serious failures last year involved investment banks overseen by the Securities and Exchange Commission, not the Fed.

But there are three more important reasons to keep the Fed in a major role as a regulator of financial institutions.

First, whatever its earlier lapses, once the crisis hit, the central bank kept the U.S. economy from falling into a depression, at times almost single-handed. It did so by using every bit of authority it had to keep the financial system functioning, often over the objections of small-minded politicians who didn’t understand what was at risk. For that alone, the Fed deserves far more praise than condemnation.

Second, it would be much more difficult for the Fed “to get back to its core enterprises” — that is, fostering maximum sustainable employment and stable prices — without the intimate knowledge that policymakers get about conditions in the banking system if the central bank is shut out of continuing oversight of banks. Another such core responsibility is the central bank’s essential function of serving as the financial system’s lender of last resort. Even in normal times, banks turn to the Fed to borrow money on occasion, and the Fed needs to know what shape an institution is in before it lends to it. Second-hand information from another regulator wouldn’t cut it.

Third, Dodd wants to create a single bank regulator, combining the functions of the Office of the Comptroller of the Currency, the Office of Thrift Supervision and the state-chartered bank supervisory functions of both the Federal Deposit Insurance Corp. and the Fed. The Fed’s bank holding company responsibilities would go there too.

Good luck.

This new agency would have to absorb the bank examiners of all the existing agencies at a time the banking system is still under enormous stress. New lines of authority would have to be developed, and many employees would have to be transferred to new locations. Confusion is far more likely than better regulation and oversight, at least for several years.

If you would like a model, think Department of Homeland Security.

The Obama administration has proposed keeping the Fed in a key role in financial regulation, and the overhaul legislation under consideration in the House Financial Services Committee would preserve a much larger role for the Fed than Dodd’s plan.

But Dodd is up for re-election next year and he is in trouble. So he has chosen the Fed as a whipping boy as seeks to take advantage of public anger over the bailouts of some large financial institutions, and in the process recast himself as a populist after years of defending banks.

Never mind what gets damaged in the process.


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