By Neil Irwin
Monday, May 17, 2010; A11
As the debate over how to overhaul financial regulation heated up last year, there was one thing Democrats and Republicans seemed to agree on: that the Federal Reserve had made major mistakes that contributed to the financial crisis and needed to have its wings clipped.
Yet as the legislation has made its way through Congress, including with a round of amendments approved on the Senate floor last week, increasingly it appears that the changes to the Fed will be relatively minimal, and largely viewed as acceptable to leaders of the central bank.
The reasons things are turning out this way vary depending on the specific provision. But they reflect at their core a combination of a subtle but savvy campaign by Fed officials to make arguments about what they view as flaws in some proposals; a less subtle but perhaps more savvy effort by financial firms, especially small banks, on the same issues; and a recognition by senators that some of their proposals may have reflected more populist anger than sound policy.
The legislation is set to make significant changes to the operations of the nation's central bank. Here is how the major policy areas affecting the Fed are playing out.'Audit the Fed'
Rep. Ron Paul (R-Tex.) has long argued for more aggressive oversight, including Government Accountability Office audits, of Fed policy, including its interest-rate-setting decisions. Amid the crisis, most members of the House came to his side, and Paul's proposal was part of the financial overhaul bill passed in that chamber last year. Sen. Bernard Sanders (I-Vt.) proposed a similar measure in the Senate, showing how the issue united populists on the left and right.
Fed officials, the Obama administration and many private economists argued that by giving Congress more ways to second-guess monetary policy, the provisions would create political pressure for the Fed to favor actions that would stimulate economic growth in the short run but lead to inflation in the long run.
Last week, under pressure from the administration, Sanders agreed to a compromise version of his amendment that would allow an intensive outside audit of Fed lending actions during the financial crisis -- but which walls off the Fed's monetary-policy decisions from congressional review. It passed the Senate unanimously, and both the Fed and Obama administration view it as acceptable. More broadly, the Fed has signaled its intention to disclose more information about its actions; last week, it posted the contracts it maintains with foreign central banks for dollar swap lines on its Web site, and is making public how much is lent under those swap lines to each of its counterparts overseas.Small-bank supervision
Senators on both sides of the aisle were unhappy with the Fed's performance as a bank regulator in the run-up to the crisis and wanted to strip it of significant responsibility. Christopher J. Dodd (D-Conn.), chairman of the Senate banking committee, yielded to the Obama administration's arguments that the Fed is the best-qualified agency to regulate the largest and most complex banks, and legislation Dodd submitted put the three dozen or so of the largest banks -- those with $50 billion or more in assets -- under Fed regulation.
But Dodd's approach would have stripped the Fed's oversight of thousands of smaller institutions. Fed Chairman Ben S. Bernanke argued that it would make the Fed less capable of managing the nation's economy overall. In particular, he argued, it would make the Fed more attuned to the interests of large financial firms as it received less intellectual ballast from banks around the country. Presidents of regional Fed banks, who had the most to lose if the Dodd bill became law, launched an effort to convince members of Congress that the Fed branches should remain the nation's main regulators of even-smaller banks.
That all might have come across as turf-defending had the Fed not been supported by a crucial ally -- small banks themselves. The Independent Community Bankers of America lobbied to keep regulation at the Fed, and the group was effective. After all, it has members in every congressional district in the country, and the executives of small banks tend to be politically connected, pillar-of-the-community types.
An amendment to keep their oversight at the Fed was approved last week with 90 Senate votes.
"I think it was lobbying by the small banks that did it," said Brian Gardner, a senior vice president at Keefe, Bruyette and Woods who analyzes developments in Washington for the investment bank. "Those banks would rather stick with the regulator they know, and launched what ultimately became a successful lobbying operation to keep the current structure."Consumer protection
When the Obama administration and congressional Democrats proposed stripping the Fed and other bank supervisors of the responsibility to protect consumers from dangerous financial products, giving that role to a new agency, Bernanke largely signaled acquiescence.
As it turns out, the Fed may gain an expanded consumer protection role anyway -- and against Fed leaders' preferences. Rather than make the new agency completely independent, the Senate version of the bill would make it a unit within the Fed, in an attempt to appease Republicans by making it seem less like the creation of a new bureaucracy.
Although the Fed technically would gain new turf should the legislation pass as it is now being discussed, Fed leaders have misgivings about the plan. The consumer protection agency inside the Fed would answer to its own presidential appointee, not the Fed chairman; yet the central bank must pay its bills, reducing the funds it returns to the U.S. Treasury each year.
Bernanke has argued that under this structure, the Fed could be faulted for mistakes the new watchdog made, yet not have any power to shape its decisions.Fed governance
One area where the Fed has not gotten its way is on shifts to how it is run. In particular, the Senate bill would make the head of the Federal Reserve Bank of New York a presidential appointee, in contrast to the current system, in which the New York Fed's board names one with approval from the Fed governors in Washington.
Fed leaders argue that the new approach would politicize a job they view as more technocratic, and that it would elevate the New York Fed president relative to his counterparts at other regional banks around the country.