A Risky Choice for an Economic Risk Regulator

By Mark R. Warner
Sunday, June 28, 2009

Over the past six months, President Obama and Treasury Secretary Timothy Geithner have worked tirelessly to rescue the U.S. economy from our nation's longest and deepest recession since the Great Depression. As the administration has shifted from crisis management to regulatory modernization, it has sought to vastly expand the powers of an opaque institution: the Federal Reserve. This is a mistake.

The Federal Reserve has largely managed its primary mission, monetary policy, with skill and success. For nearly 25 years since Paul Volcker tamed inflation, the United States has benefited from low and stable interest rates. Chairman Ben Bernanke and his board continue to ably navigate monetary policy through difficult times.

Yet the basic question we must ask of reform is: Will these proposed changes improve our chances of avoiding the next crisis? This question is not partisan or ideological. Getting financial reregulation wrong can have major unforeseen consequences.

The events of the past two years have underscored the need for regulation of the financial markets that anticipates and mitigates systemic risk. The events of the past 20 years have demonstrated that the Federal Reserve is the wrong choice as a systemic risk regulator.

First, the Fed has proved itself incapable of managing and preventing systemic risk. Second, sound monetary policy is too important to place at risk with conflicting or diverting responsibilities. Third, the Fed is not structured to provide the transparency and accountability the public deserves. Fourth, this action could concentrate too much economic power in a single institution.

Some have advocated giving more responsibilities to the Fed because it is the only institution sophisticated enough or the only one with the will and motivation to act properly. But those arguments are demonstrably wrong.

Leading up to this crisis, the Fed was the de facto regulator of systemic risk and was previously given enhanced powers to regulate consumer mortgages. Most observers recognize that the Fed's decision not to use powers that Congress granted it in the 1994 Home Ownership and Equity Protection Act helped precipitate the current crisis.

Some may also remember that in the face of Citibank's near-failure in 1991, we realized that the failure of one institution could threaten the system. The Fed was given the tools and responsibility to prevent firms from becoming too big or interconnected to fail. But even now, the potential failure of Citigroup or that of other large banks menaces our financial system.

The Federal Reserve's primary responsibility is to conduct monetary policy to achieve twin objectives: price stability and full employment. The qualifications and experience required to tackle monetary policy differ from those needed to regulate complex financial institutions, including securities and insurance firms. It is unlikely that the best person for each job would consistently be the best person for both.

Over the next decade, as the United States confronts what may be the most important monetary policy challenges in our history, expertise in monetary policy and singular focus will become ever more important.

What we need is an all-inclusive Systemic Risk Council with an independent chair appointed by the president and confirmed by Congress, and a membership including the Treasury secretary, the chairman of the Federal Reserve and other prudential regulators. A council with an independent staff, the ability to gather any financial information it needs to spot systemic risk, and prophylactic and emergency powers to deal with such risks would be much more likely to stop the next crisis.

Secretary Geithner has told Congress that you cannot convene a committee to put out a fire. But we do convene committees to prepare for and respond to large-scale crises. Boards work well in a range of contexts, provided they have the right responsibilities, membership and powers. Our military has the Joint Chiefs of Staff; the National Security Council coordinates our intelligence services; and even the Federal Reserve is a board.

We have resisted creating an all-powerful central bank to this point, and the experiences of countries that have concentrated too much power in one entity serve as cautionary tales. A council would allow for a system of checks and balances.

The council would focus on one job: systemic risk. By its nature, it could see across the full horizon of banking, securities, insurance and private equity and better anticipate the risks that emerge in an innovative financial sector. Prudential regulators would remain empowered and responsible for systemic risks arising in their jurisdictions. If threats extend beyond the authority of one regulator, the council would ensure comprehensive, coordinated action.

To ensure that monetary policy and systemic risk are each managed in the best possible manner, we must recognize that institutional structures and responsibilities matter. Doubling down on a structure of the past that has not performed well outside of its core function is not the way to confront the challenges of the future.

The writer is a Democratic senator from Virginia. He was governor of Virginia from 2002 to 2006.

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