The Fed as systemic risk regulator

September 24, 2009

In his testimony before the House Financial  Services Committee, economist Mark Zandi draws light to a problem I have been talking about and then offers a solution:

The principal worry in making the Federal Reserve the systemic risk regulator is that its conduct of monetary policy may come under overly onerous oversight. Arguably one of the most important strengths of our financial system is the Federal Reserve’s independence in setting monetary policy; it would be counterproductive if regulatory reform were to diminish even the appearance of this independence. This will become even more important in coming years, given prospects for large federal budget deficits and rising debt loads. Global investors will want to know that the Fed will do what is necessary to ensure inflation remains low and stable. To this end, it would be helpful if oversight of the Fed’s regulatory functions were separated from oversight of its monetary policy responsibilities. One suggestion would be to establish semiannual reporting by the Fed to Congress on its regulatory activities, much like its current reporting to Congress on monetary policy.

And here is how Paul Volcker sees all this working:

I am not alone in suggesting that a Fed governor should be nominated by the President and confirmed by the Senate as a second Vice Chairman of the Board with particular responsibility for overseeing Regulation and Supervision. The point is to pinpoint responsibility, including relevant reporting to the Congress, for a review of market developments and regulatory and supervisory practices. Staff authority, independence, professionalism, experience, and size should be reinforced.

Me:  I don’t see how Zandi’s solution would solve anything. Maybe the new vice-chairman would do most of the testifying about regulation rather than Bernanke? I think the true answer is that a lessening of independence is just a risk Zandi and Volcker are willing to take.

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