Why Treasury shouldn’t regulate banks

By Felix Salmon
February 19, 2010
his latest proposal gives that job to the Treasury Secretary, of all people. This is not a good idea, as Karen Shaw Petrou says:

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Wow, Democratic Senator Chris Dodd really doesn’t want the Federal Reserve to be the main systemic-risk regulator — to the degree that his latest proposal gives that job to the Treasury Secretary, of all people. This is not a good idea, as Karen Shaw Petrou says:

“I don’t see how you avoid fundamentally changing the role of the Treasury Department as a member of the executive Cabinet,” said Petrou, managing partner of Federal Financial Analytics, which tracks regulatory issues for industry clients. “One would hope the Treasury would exercise its powers in a virtuous way, but this is not what Treasury is nor what it should be.”

If the Treasury secretary had a formal supervisory role, that official could use the position “to meet the political exigencies of the moment or for an upcoming election,” Petrou added.

On top of that, remember what we saw at the beginning of 2009: Treasury can be a very chaotic place when the White House changes parties. What’s more, substantially all top Treasury officials are political appointees: it simply is not the kind of place that you want to be setting long-term macroprudential principles. Give bank regulation to Treasury, and you’ll end up with a system where regulators care more about banks’ presence in Iran and Cuba than they do about their leverage ratios.

But it gets worse:

During negotiations with Dodd this year, Sen. Richard C. Shelby (Ala.), the ranking Republican on the banking committee, suggested having the Treasury secretary lead the council. Shelby viewed that structure as preferable, in part because the Treasury secretary has a higher international profile than most regulators. He also views the Treasury secretary as more accountable to Congress.

I suppose it makes sense that a member of Congress would want to have anybody and everybody maximally accountable to Congress. But that doesn’t make it a good idea. Regulators are like judges: they work best with a minimum of political interference. We saw that with the regulation of Fannie Mae and Freddie Mac: it got hijacked by Congress to the degree that the nominal regulator was to all intents and purposes powerless to do anything but that which Congress demanded. And the consequences were disastrous.

So this is yet another reason — as if one were needed — to be pessimistic about the prospects for financial reform. I’m becoming increasingly convinced that if anything passes the Senate at all, it’s going to be so weak as to be largely pointless. We’ve wasted our crisis.

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