The writer, chairman of the Federal Reserve from 1979 to 1987, is founder and chairman of the Volcker Alliance, which on Monday will release a report proposing reforms of the financial regulatory system.
It has been a long slog for the economy since the last and by far the most severe financial breakdown in my experience almost brought our economic system to its knees. Right now, in the wake of unprecedented trillions of dollars in budgetary and continuing Federal Reserve support, the U.S. economy is doing better than it has in nearly a decade. Unemployment is down. Credit is, for the most part, reasonably available to industry and home buyers. However, even as the United States continues its long climb back from the financial crisis, it is all too clear that the federal financial regulatory structure is simply inadequate to head off future crises. The structure that failed us in anticipating and responding to the emergency is largely still in place.
Important progress has been made, here and internationally, in shoring up banking regulations, notably through stronger capital requirements. The Dodd-Frank Act has added oversight bodies — the Financial System Oversight Council and the related Office of Financial Research.
But, basically, the institutional structure for financial regulation — which traces its origins to the 1930s — has resisted repeated efforts for meaningful reform. As a result, what we see in full view are inconsistencies in approaches among the half-dozen or more regulatory agencies, differing priorities, overlaps and gaps, squabbling over turf, incentive for competition in lax regulation; and too many opportunities for agency “capture” by those regulated.
Equally important, and a large new challenge for financial regulation and supervision, has been the multiplying innovations in finance and the proliferation of complicated and often opaque instruments outside the formal (and heavily regulated) commercial banking system. Commercial banking has become dominated by enormous institutions engaged in a complex combination of activities and operating across many countries. The free flow of capital internationally has further challenged the dispersed institutions responsible for regulation and supervision.
Not so long ago, a frame of mind held sway that financial markets could and should take care of themselves. It was believed that a combination of competition, rational expectations and self-interest would work against excessive risk, minimizing the chance of a serious and contagious breakdown requiring extraordinary public support. In the face of events in recent years in the United States and abroad, few responsible officials, supervisory agencies or even theoretical economists can sustain that view any longer.
So the need for review and reform of the institutional structure is imperative. When I question whether the existing regulatory framework makes sense, I do not hear an affirmative view, whether from officials, bankers, other participants in financial markets or informed members of the public. Indeed, some of the most eloquent concerns have been expressed by the two most recent treasury secretaries, who, while in office, had to deal with the financial crisis and organize a collective defense.
I am also well aware that when I ask about the prospects for reform, the almost-uniform response is “hopeless” — too many vested interests (including regulatory agencies accustomed to the status quo), too sensitive in terms of the jurisdiction of congressional committees and, like everything else in Washington, too heavily lobbied by particular private interests protecting their preferred agencies.
I was, to put it mildly, not born yesterday. I have observed, even been a small part of, some of the 20 and more failed efforts under both Republican and Democratic leadership since World War II to redesign the financial regulatory system. But I also know that, after all that has happened, resistance to some fundamental change is hard to justify.
We need to make sure we have institutions with clear mandates, adequate financing and dedicated personnel insulated from partisan and particular political pressure.
The objective can’t be questioned. The need for institutional reform is evident. Let’s break the pattern of resisting the need for administrative reform, consider the risks of repeating avoidable crises and demonstrate that this great democracy still has the capacity to act in the common interest.