Don’t give the Fed a new job
— Mark T. Williams, a former Federal Reserve Bank examiner, teaches finance at Boston University’s School of Management and is writing a book on the rise and fall of Lehman Brothers. The views expressed are his own. —
In the real world, outside the Washington Beltway, when someone does a bad job they do not get more work. The Council of Institutional Investors and the CFA Institute Center for Financial Market Integrity task force report agrees with this fundamental point: Don’t give the Fed the new job. As an ex-Fed examiner, I applaud this conclusion.
Creating an independent Systematic Risk Oversight Board (SROB) to monitor firms that pose significant risk to the market would inject new honesty to regulatory supervision. This sound proposal comes at a time when Treasury Secretary Geithner would like to give his former employer, the Fed, additional regulatory duties even if they have failed to earn this right. The report also is critical of previous light-touch regulation. The SROB would provide a firmer approach, not repeating the mistake made by the Fed of coming with a knife to a gunfight.
A new oversight board would provide a fresh approach to preventing banks and other financial firms like insurance companies from engaging in risky and financially harmful practices. Importantly, the task force report recommends restricting risk-taking activities, forcing banks to refocus on their core competencies – taking in deposits and making loans. Although banks can get into trouble making loans, such activities are more transparent and easier to monitor than the trading of derivatives that, in a flick of a finger, can blow up a firm. The report also advocates strengthening capital adequacy standards, important for a cushion against losses and insolvency.
Traditionally, banks have made money only three ways — loan interest, fees for services, and trading. It would be extreme to say that all banks should be restricted from trading. But there are many that lack the expertise, capital, trained staff, or sophisticated monitoring systems needed to adequately measure, monitor and control risk.
In a capitalistic system it is important to allow market forces to work so that risk taking is adequately rewarded and excessive risk taking is penalized. However it is equally important to make sure that risky practices of banks do not come at the expense of broader market disruption, economic decline, lost jobs, and financial hardship.
The banking industry is at a fundamental inflection point. To say, “It’s business as usual, let the Fed do the heavy lifting,” does not address the underlying problem. How much risk taking should be allowed and how much concentrated financial power should be permitted in the hands of a few banks and non-bank financial firms is a paramount policy issue.
Since 2008, the five largest independent Wall Street investment banks — Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers, and Bear Stearns — have gained banking powers, been merged with other banks, or were purged by the market. (Goldman’s latest quarterly earnings of more than $3 billion in profit, most from risky trading, stunned the Street.) Over the last decade there also has been a rapid movement towards “universal” banking. Examples include Citigroup, Bank of America, Barclay, HSBC, and Deutsche Bank that provide a full array of risk-taking products from commercial loans to derivatives trading. And, increasingly, large insurance companies are acting and feeling like banks.
Concentrated power in our regulators can come at too high of a cost because this new breed of risk takers need to be regulated and examined differently. Establishing an independent oversight board outside of the Fed also sends an important message to the market that regulators will no longer be rewarded for a job poorly done.
Not until we established more of a performance-based regulatory system and increase accountability at the agencies entrusted to protect us (e.g., the Fed, FDIC, OCC, and SEC) will our regulatory system begin to operate effectively. If the Fed thinks it can do a better job, it will have the opportunity to earn back the trust of the market and, if successful, the task force oversight board could eventually be phased out.
More eyes viewing banking activities can only assist in better risk identification, monitoring and mitigation, before excessive risk taking is allowed to occur again. The market, the economy, and the American people have suffered from lax regulatory oversight. A new, independent Systematic Risk Oversight Board is a step in the right direction.