The Obama administration wants the Federal Reserve to be the maximum regulator of the American financial system. As Treasury Secretary Timothy Geithner told the Senate Banking Committee, “The Federal Reserve is best positioned to play that role. It already supervises and regulates bank holding companies, including all major U.S. commercial and investment banks.”
The problem, of course, is that most informed observers have concluded that the Fed failed to adequately supervise and regulate banks during the lead-up to the financial crisis. Count Senator Chris Dodd, chairman of the Senate Banking Committee, in that camp. “There’s not a lot of confidence in the Fed at this point,” Dodd said right after the White House released its financial reform proposal.
This is where Daniel Tarullo makes his appearance. The newest member of the Federal Reserve has apparently authored a plan to have the central bank approve compensation policies potentially But previous to joining the Fed, Tarullo was an influential economic adviser in the Obama presidential campaign.
So now what we have, I think, is Obama’s man at the Fed pushing a politically savvy plan that could bolster the Fed’s standing as a tough regulator in the eyes of Congress and deflect some of the criticism of the central banks past failings. Score one for the White House in its push to make the Fed super-regulator.
Surely, the timing couldn’t be better. Not only has the administration been refocusing attention on passing financial reform – witness the president’s tough Wall Street speech – but next week’s G-20 meeting will include extensive discussion about banker pay issues.
But this is a case where good short-term politics makes for bad long-term bad policy. The greater the Fed involvement in the regulatory process, the greater attention it will receive from Congress – and the greater the threat to its cherished independence.
As it is, the Fed’s historic efforts to rescue the financial system have raised concerns on Capitol Hill that it has too much power with too little oversight. That’s why Rep. Ron Paul’s bill to audit the Fed, according to Financial Services Committee Chairman Barney Frank, will pass the House this year. (Indeed, what Paul really wants to do is end, not mend the Fed.)
Really, could anyone possibly believe that having the Fed become the pay czar at 5,000 banks would lessen congressional interest in its activities, including monetary policy? Not to mention that a better solution to excessive financial risk taking is the restoration of market discipline on Wall Street.
Better that Wall Street understand the consequences of poorly incentivized pay structures. “Too big too fail” remains the biggest threat to America’s fragile financial system.