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Under the Treasury's Plan, Fed Would Lose a Key Power
Ben S. Bernanke, chairman of the Federal Reserve, says the Fed relies on its power to monitor banks, a power it would lose under the plan.
(By Manuel Balce Ceneta -- Associated Press)
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Bernanke also argued that understanding banks helps the Fed better decide how to set interest rates to try to balance strong growth with low inflation. That is because Fed policy operates on the credit system. When it cuts rates, banks make that cheaper money available to ordinary Americans to stimulate the economy.
From the Treasury Department's point of view, an overhaul is needed because the system of banking regulation has too much redundancy. With many agencies, firms being regulated face bureaucratic headaches and regulators may feel less need to be accountable.
The current patchwork has evolved since the Civil War, offering different rules and different regulators to nationally chartered banks, state-chartered banks, thrifts and credit unions. All these institutions started with different purposes and roles in the financial system but increasingly do similar work.
That mix of institutions can create problems because information is compartmentalized in different bureaucracies. It may have contributed to the current financial crisis. Because each agency was focusing on applying a narrowly tailored set of rules, rather than examining the big picture, conflicts of interest among mortgage brokers, banks and the investment firms that package mortgage loans got little attention from regulators.
"The problem wasn't necessarily too much regulation or too little," said Ross Levine, a Brown University professor who studies the banking system. "The problem was regulators did not adapt to financial innovation and make sure that information was transparent. No regulator looked broadly at the conflicts of interests being created."
In this fragmented system, financial companies can engage in "regulatory arbitrage," expending vast amounts of effort deciding what kind of charter to operate their businesses under, in effect choosing what sort of rules apply to them.
But there are some advantages to the current system, too. With a mix of regulators, mistakes by one agency can be partly made up for by others. And there is a long history of powerful financial regulators behaving improperly, either through overt corruption or by becoming too beholden to the industry they oversee.
Even if Congress approves some version of the Treasury plan, it will be an enormous bureaucratic task to implement it.
"It's easy enough to say that the current system doesn't make any sense, that it's a crazy quilt of regulators," said David O. Beim, a finance professor at Columbia Business School. "But it's very difficult to put institutions together. People howl and protest; there is turf to be protected. It is painfully difficult to merge institutions that don't want to merge."
