Tough going for bid to pare Fed

Business Times - 17 Nov 2009

Tough going for bid to pare Fed


US LAWMAKERS have been drawing plans on how to reform financial regulations and prevent another deadly meltdown, more than a year after the economic crisis started.

At the centre of the debate on Capitol Hill has been the role that the US central bank should (or shouldn't) play in regulating financial institutions.

Federal Reserve chairman Ben Bernanke, who is backed by President Barack Obama and his top economic aides, wants the Fed to take upon itself the responsibility of a top regulator. Both Republican and Democratic critics argue that the Fed has not had a very strong record as a regulator and want to deny the Fed any new regulatory powers.

Hence, while legislation offered by Democratic Representative Barney Frank of Massachussetts, the chairman of the House of Representatives' Financial Services Committee, posits a powerful bank regulatory role for the Fed, a bill proposed by Democratic Senator Christopher Dodd of Connecticut, chairman of the Senate Banking Committee, consolidates all federal bank regulators into one agency and strips the Fed as well as the Federal Deposit Insurance Corporation (FDIC) of the power to regulate banks.

Introducing his plan last week, Senator Dodd criticised the Fed's current regulatory power and proposed that the central bank focus on its traditional role in setting monetary policy.

'We saw over the last number of years, when they took on consumer protection responsibilities and the regulation of bank holding companies, it was an abysmal failure,' Mr Dodd said.

'I really want the Federal Reserve to get back to its core enterprises, in a sense, to do what it's designed to do, monetary policy, dealing, obviously with a lender of last resort, the payment systems. Those are what they're designed to do.'

In fact, the Fed has been under fierce political attack from populists on Capitol Hill since the start of the financial crisis. For example, libertarian Republican Representative Ron Paul of Texas, supported by both Republicans and Democrats, has authored a bill that would audit the central bank's monetary policies and decisions.

Mr Bernanke has expressed his opposition to the bill which, he argued, could lead to the politicisation of the independent central bank.

Mr Dodd and others who support the idea of having one powerful regulator note that the financial mess had occurred under the watchful eyes of the Fed.

Among other things, the Fed was responsible for regulating the mortgage industry and bank-holding companies. As well, the other current banking regulators who didn't seem to have the power or the will to scrutinise the conduct of the large financial institutions were able to exert much political influence in Washington.

Indeed, as many analysts have pointed out, financial institutions could shop around and pick federal regulators they liked. So, replacing that fragmentary regulatory system with one strong and effective regulator would have the power to resist these political pressures and take a tough stand with the financial industry.

One of the main reasons that Obama administration officials oppose Mr Dodd's plan is their concern that political opposition by the powerful financial institutions, which maintain a legion of lobbyists on Capitol Hill, would make it close to impossible to consolidate all the current regulators into one powerful entity.

Indeed, bankers who seem to be comfortable with the status quo are bound to use all their available power to challenge Mr Dodd's legislation, leading to a long legislative stalemate. From that perspective, the plan promoted by Mr Frank and supported by the White House has a better chance of being approved sooner than later.

Moreover, there is a danger that creating a single, consolidated bank regulator as well as transferring the Fed's responsibility for consumer protection of financial products to the new agency, could end up centralising too much power in the federal government in terms of regulating what are essentially private financial markets. That, in turn, would also allow lawmakers in Congress to put pressure on the new federal agency to pursue their narrow political interests.

The Fed, on the other hand, is supposed to be immune to that kind of political influence. And the central bank's role in conducting monetary policy requires an ability acquired through its regulatory function to monitor the financial system.

Indeed, critics of Mr Dodd's plans note that Britain has the kind of regulatory agency independent of the central bank which clearly failed to respond effectively to the financial crisis there.

In any case, neither the legislation in the Senate nor in the House of Representatives seems to provide any coherent plan to deal with the too-big-to-fail financial institutions, the gigantic banks - that if they fail - would bring down the system.

At the end of the day, the legislation that emerges from Capitol Hill will probably look more like the bill proposed by Mr Frank, under which the Fed assumes the role of the Big Regulator.

At the same time, as part of an effort to placate the Fed's critics in Congress, lawmakers will also approve legislation aimed at making the workings of the central bank more transparent.

Copyright © 2007 Singapore Press Holdings Ltd. All rights reserved.


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