Don’t give the Fed a new job

July 16, 2009

williams_mark— 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.


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MTW: “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.”

The above more or less parrots the central conclusions that many have come to; that is, regulatory powers were applied far too laxly.

But, let us remember, it was the head of state (the PotUS) that sets the level of exigency regarding regulatory powers. The President makes the sun shine and the rain fall on market regulation by selecting the heads of regulatory control bodies.

I maintain that the key problem with Wall Street was not regulatory, but simple cupidity. For which, the sole solution is the establishment, beyond a certain level of compensation, of confiscatory marginal taxation. I suggest 5 megabucks a year as the threshold.

Wall Street financial prima-donnas will have to content themselves with ONLY five million dollars in total annual compensation. Not billions of them, but less than five million dollars. (And, I certainly would not want one of them living on my street.)

Otherwise, I am willing to bet my bottom (entirely) that this crisis will be destined to recur. There is too much greed afoot on Wall Street, whilst Main Street pays the piper for their immorality. It is a sad testimony to the lamentable state of American morality today.

Anything for a buck. Anything.

Posted by Lafayette | Report as abusive

Who funds the board?

Who can disband the board?

In other words, who can influence the Board!

Is this going to be like the FDA where drug industry insiders run the agency?

It is not that the FED can’t do it. They FED was doing what it was told. When greed infuses every office from the President to the Congressmen to the Banker and that Good ole Boy CEO System remains in place you will never have control of the markets. Bubbles will come, people get rich, bubbles burst and other people get poor. With unemployment climbing and mortgage and credit card defaults soaring out of sight who pays? Who gets stuck with the crap, the working class of the US. We will have to pay this back or pay for it with climbing interest rates. People lied, people defrauded, people ordered regulators not to investigate and where are these people now? Well folks they aren’t in jail where they belong.

Basically what I am saying regarding the suggestion in this piece is that is does not matter. Today’s criminals are not gun slinging thugs. The real criminals in this country are educated politicians, bankers, insurers and CEOs who get away with bringing a nation to its knees. No economic system can work if those within that system have no integerty.

Posted by B.Free | Report as abusive

MTW: 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.

Fine, Mr. Williams, but who polices the police.

Systemic failure occured because across the board regulatory powers were lax under and administration blindly wedded to the stupidity that “the markets always get it right”.

The charter writ for the Fed is perhaps insufficient. No Fed chairman interpreted the charter to investigate the nature of Structured Investment Vehicles and the nature of their creditworthiness, that caused the Great SubPrime Mess of 2008. When we want to point the finger of blame in that matter, we point where? Some other agency that was supposedly responsible the Truth In Lending Act?

The Fed oversees much of the range of financial transactions, including banking and excluding securities. But, if a Greenspan wants to apply Regulation-Lite, what is a poor Fed examiner to do? Bolt?

No, s/he shuts up and does the job they are told to do.

Posted by Lafayette | Report as abusive

Hello Mark,
I like your statement:

MTW: “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.”

Between us big CAPITALISTS, who was penalized for “excessive risk taking” in case of Lehman brothers or AIG?

Executives? Yep, they suffered. With economy goes south they lost jobs and now have to count every million on their private accounts.

Lehman? Yep, as a bank it paid ultimate price, but after all it was a legal entity not a live creature that suffers pain of death.

Shareholders? They suffered most. Te whole investment was wiped out. But with broken corporate governance all across US they had very little control over events. In every big corporation executives are shielded by hand picked boards.

Tax payers. Why they have to suffer and pay 168 BIL to bail out AIG and etc? It sound like communism to me – everybody gets as much as he/she needs.
Banks and even insurers became vehicles to extract profit at any cost without thoughts beyond next bonus.

Capitalism failed there. Society cannot allowed bad guys to fall.

In your abbreviation SROB the key letter ‘I’ stays for ‘independent’ and it is absent.

Don’t forget every bank including Lehman had/has Risk controllers. They all failed badly. So the body must be independent.

FED doesn’t have infrastructure and expertise in measuring risk. But the truth is that nobody has.

Posted by Sergey | Report as abusive

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