Felix Salmon

Why the Fed should regulate banks

By Felix Salmon
January 19, 2010

George Cooper asks whether or not banks should be regulated by the central bank, noting drily that “America sees salvation in replicating the failed British banking experiment while Britain sees salvation in returning to the equally discredited American model”. He adds:

I am happy to make my small voice heard in support of Mr Volcker. He is right when he says “It simply doesn’t make sense, as then Fed Chairman Mariner Eccles complained during the Great Depression, that the efforts of the Federal Reserve to ease money be to some degree frustrated by overzealous banking regulators determined to restore bank capital and assure strong lending standards.” For this reason it is best to view monetary policy as requiring both interest rate and regulatory policy levers.

That said, it is pointless to give the central bank control of both levers if it is unwilling to use them or chooses to push them in opposite directions.

There’s no doubt that the current US administration in general, and Bernanke’s Federal Reserve in particular, is indeed currently pushing those levers in opposite directions. Monetary policy is very loose, while everybody is agreed on the need to tighten up banking regulations substantially.

Where I part company with Cooper is when he determines that this is necessarily a bad thing. If the Fed’s in control of both regulating banks and setting monetary policy, then it can put together an optimal combined approach, or at the very least take account of one while working on the other. We have to crack down on bank leverage? OK, then we might have to cut rates a bit more.

If by contrast the banks are regulated by some other institution entirely, the Fed has to second-guess what that institution is going to do in the future, and that’s never going to be easy.

During the credit bubble, it’s now clear, one of the Fed’s biggest failings was that it not only kept interest rates too low for too long, but also abrogated all responsibility over what Cooper calls the regulatory policy lever. It could have cracked down much harder on mortgage lending, but didn’t. There is a chance, however, that it can learn from its mistakes — especially if it’s given regulatory authority over non-bank lenders and other actors in the shadow banking system.

Anybody else given broad regulatory authority — and someone needs to have it — would need to work hand-in-glove with the Fed in any event, especially when it comes to questions such as the Fed paying interest on reserves. And there’s no particular architectural reason not to give the Fed those powers — objection to the idea comes overwhelmingly from the fact that this Fed has made so many mistakes that people don’t trust it to do the right thing in future.

But the fact is that if you try to build a bank regulator from scratch, it will take decades to find its feet and learn from its mistakes. The Fed, with any luck, has reached that point now. Let’s give it regulatory authority, and cross our fingers it uses them wisely.

6 comments so far | RSS Comments RSS

Spot on, Felix. Absolutely spot on.

Posted by dWj | Report as abusive

On the other hand there are those of us who refuse to buy cable because we don’t want our basic cable fees going to support the greedy, gluttonous and hateful Christians wagging their fat fingers in our faces about how sinful we are and how saved they are. Or to PAY to watch an hour of programming that consists of more than 20 minutes of advertising.

I only watch TV if I’m out of town and staying in a hotel that has cable. But I don’t understand how would you meter it if I spend 10 or fifteen minutes flipping thru channels trying to find anything interesting to watch. Do I have to pay for every show I watched for 30 seconds to 5 minutes? How do you challenge your bill when you get it?

Posted by TimC | Report as abusive

How did I end up leaving that comment on the wrong post? Sorry.

Posted by TimC | Report as abusive

It’s a good argument that the Fed should control both the monetary policy lever and the financial lever to better aid in the coordination of both levers. However, it’s not clear that both levers need be controlled by the same institution.

You wrote “[i]f by contrast the banks are regulated by some other institution entirely, the Fed has to second-guess what that institution is going to do in the future, and that’s never going to be easy.” However, there’s a very good counter-example to this problem, namely the control of fiscal versus monetary policy. These two levers are (usually) successfully by (mostly) independent parts of the gov’t, with the best example of their failure to properly coordinate being when Arthur Burns failed to adhere to a sufficiently independent policy in the 1970′s. Since then, the Fed and the gov’t had done a reasonably good job of coordinating their respective policies, with the Fed’s independence being the core reason for the Fed’s existence.

One could make a similar argument for the benefit of having financial regulation separated from the Fed. The goal of the regulator is somewhat distinct from the goal of monetary policy — having different people guide each policy could prove beneficial.

Posted by Kosta0101 | Report as abusive

The government wants Americans to believe the greatest economic collapse in history was the result of ineptness and mistakes yet still have confidence in their financial institutions.

Should American bankers be let off the hook because they self-declare, before an investigational panel, that the failure of their newly invented risk swaps and other highly leveraged investment schemes was simply due to “mistakes”? Not malfeasance – just every-day mistakes? Bankers just fell asleep at the helm at a critical juncture in American history. Is that what we are being led to believe?

Oh well, it’s just 18 million American homes that now lay empty in the wake of unprecedented foreclosures, and the bankers have collected obscene bonuses for reckless lending of their depositors’ money. It’s like the captain and crew of a ship saying, not to worry, twenty-percent of the passengers were lost overboard, but this was due to unavoidable mistakes, and then being rewarded with bonuses when they reach port.

All that Americans have left is their fiat currency (the Federal Reserve controlled-Dollar), more than 80% of our industry has been moved off-shore. We can’t even increase exports since we have absolutely nothing to export except fiat-money.

So when Alan Greenspan tells the Gulf States to decouple from their dollar-peg, it is not by accident. http://www.gulfnews.com/business/Economy  /10192824.html

So the American public, who can’t even find the US on the world map and can’t name the three branches of the Federal government has no idea what is going on.

The useful idiots who wrote that its a good idea for the Fed to take over bank regulation are the same people who thought that the past 18 months were impossible. The Federal Reserve is a private company. it is owned by its twelve federal reserve branches who, are in turn, owned by the Rothschilds, Rockefellars, and Royal familes of Britain and Holland.

Posted by infowars | Report as abusive

First let it be know that I am not an English scholar and there will probably be grammatical mistakes in this posting.

The question is do we allow the Federal Reserve to regulate banks? The simple answer is no. There are also simple explanations to this complicated issue, which only can be obtained through common sense.

There has always been housing bubbles and all have burst.
Most, if not all, housing bubbles are created by the government. Not only our government but ever government of the world.

Banks and the bursting housing bubble is not the problem. The problem is Washington politicians buying votes with easy money, borrowed from the Federal Reserve, from both parties.

It is a fact that the Federal Reserve is privately owned. It is a little know fact that the Federal Reserve is the only institution in this country, that cannot be audited by the Federal Government.

So, if bank regulator authority is turned over to the Federal Reserve, the question becomes who regulates them?

If you missed it the first time I will say it again. It is the Federal Government and the Federal Reserve, not the banks that is the problem.

Posted by MSGret1 | Report as abusive

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