Delegating Super Powers

By Sharyn O'Halloran

The great non-bailout bailout of ’08—the shotgun wedding (heard around the world) of Bear Stearns and JP Morgan—has generated widespread calls for a new, more capacious regulatory environment in which a Super Regulator (for instance, the Fed), will be delegated super powers to monitor firms’ risk profiles and demand higher reserve ratios to make it less likely that a single firm’s collapse can bring down the entire economy. The Treasury’s long-awaited “blueprint” for streamlined regulation, for instance, was finally released publicly, even though it failed to address the types of transactions that led to the Bear Stearns collapse.  The idea is to bring the shadow banking system out from under its penumbra and into the light of day.  

While this logic has gone from radical to common wisdom in the space of a few short weeks—the Treasury had delayed releasing its blueprint for month for fear that it would destabilize financial markets—its corollary has yet to be fully understood: namely, that the Fed will need to acquire a parallel set of obligations vis-à-vis elected officials. Let me explain. 

The Federal Reserve actually has two functions. In the first, acting though its Open Market Committee, the Fed sets the federal funds rate and the discount rate; the combination of these instruments determines the rates at which banks lend money to consumers. Its other, lesser-known, hat is that it acts as one of the chief regulators of the banking system. For a bank to open a new branch, for instance, it needs Federal Reserve approval. International financial institutions seeking to do business in the US are also subject to Fed supervision.  It is not for nothing that the entire Federal Reserve System employs over 20,000 individuals at an annual cost of over $1.2 billion. It is this second role that allows the Federal Reserve to make loans to individual banks, extend credit, and act as the lender of last resort, including its $29 billion “loan deal” to facilitate JP Morgan’s acquisition of Bear Stearns, which looks an awful lot like an equity purchase. 

And here is the rub. The Fed’s actions to salvage the financial system were bold, innovative and probably necessary. In its former roles as setter of monetary policy and overseer of the banking system, the Fed operated in relative autonomy. But in its new guise as Super Regulator, performing deeds of derring-do to rescue helpless (hapless) investment banks tied to the railroad tracks and about to be run over by structured investment vehicles, the Fed is itself taking on additional responsibilities without the accompanying political oversight. Standard theories delegation and discretion argue that in politically sensitive areas such as using taxpayer monies to cover billions of dollars of bad loans made by private sector financial institutions, elected official will want to have, and properly should have, a role. 

For instance, no one in the frenzied weekend of deal making bothered to notify congressional committees as to what was transpiring; the Fed will no doubt be feeling some of the backlash for its political misstep in Senate Banking Committee hearings later this week. 

This does not mean that Congress has either the desire or the capacity to micro-manage the Fed’s actions; indeed, committees will need to hire specialized staff members just to regulate the regulators. Especially in current times when banks are continually, devilishly inventive, devising new ways to move risky transactions off the balance sheet, Congress needs the expertise possessed by Fed officials to keep a handle on the system.  But just as importantly, the Fed needs the cover and legitimacy that only elected officials can provide when taking actions claimed to be in the public interest. As it now stands, the Fed has the enforcement powers of the DOJ combined with a hands-off system of minimal oversight. In the long run, this is a recipe for disaster. 

So by all means, let us give a single regulator the authority needed to oversee and efficiently manage the safety and soundness of our financial institutions for transparency and accountability. But at the same time, the amount of discretion such a super regulator will and should have must be balanced by the public’s need for transparency and accountability in the regulator’s own actions as well. 

Comments

[Tony]

*****must be balanced by the public’s need for transparency and accountability in the regulator’s own actions as well. ****

I have been arguing these two points for the past 20 years. Without transparency, accountability, checkers who check and balancers that balance, with an imperial president and a congress in the bleachers, what have we got? Where are the class action lawsuits? There is no accountability because the bureaucrats don't know what they're asking for. They rely on contractors to do their work. With all the privatizing going on, why is the federal payroll going up? Who is protecting the home buyer from the predatory lender? I thought I was rid of the Countrywide guy, but he's back!