Tying the Fed’s hands

September 29, 2009
high-level UN report on regulatory reform says that sometimes regulators need to have their hands tied:

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Joe Stiglitz’s high-level UN report on regulatory reform says that sometimes regulators need to have their hands tied:

181. It is not enough to have good regulations; they have to be enforced. The failures in this crisis are not just a failure of regulation but of regulatory institutions that did not always effectively implement or enforce the regulations. In this crisis, the regulatory performance of many central banks has been far from stellar. They did not adequately enforce and implement the regulations at their disposal, and they did not alert governments to the need for additional regulatory authority or restructuring authority when existing authority was not adequate…

186. In light of this pressure, it may be necessary for part of the regulatory structure to be “hard wired,” limiting the discretion available to regulators and supervisors. Counter-cyclical provisioning and capital adequacy requirements of the kind discussed in previous sections should be rule-based, while adjustments to regulation due to evolution of financial practices and innovation will require monitoring and discretion in adjusting regulations as appropriate.

In other words, since regulators have a tendency to get captured, don’t let give them too much discretion — and any changes in regulatory oversight should be done explicitly, through changing regulations, rather than by nod-and-wink.

Interestingly, this is exactly the route chosen by the Obama administration to implement the Credit Card Act. Rather than simply impose new rules directly on credit card companies, the Act forces the Fed to impose those rules. Accordingly, the Fed today issued a formal proposal for implementing the rules which Congress has already mandated. Congress tells the Fed what to do, and then the Fed goes ahead and does it.

There’s a lot to be said for this kind of structure, which makes it much harder for regulators to quietly and unilaterally determine that, hey, why bother. But at the same time, it’s a lot easier to force the Fed’s hand in narrow and easily-defined areas like credit card regulation than it is in something as big and vague as systemic macroprudential risk management. Ultimately, macroprudential regulation can’t be rules-based: there has to be some other mechanism by which citizens can have justifiable faith in their regulators.

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