The Dodd-Frank reform legislation had multiple goals: among them, preventing a repeat of the financial crisis by closing regulatory gaps and, through the Financial Stability Oversight Council (FSOC) it created, identifying and addressing systemic risks before they damage our economy.
Spotting the next big issue is critical — but it is both extremely hard to do in itself and, even when threats are identified, it can be difficult to achieve necessary change.
Consider, for example, the nation’s debt problem. It’s widely known that the United States has large deficits and spiraling entitlement obligations and is spending at an unsustainable rate. Yet many in Washington continue to kick the can down the road, and the discussion focuses on short-term spending deals merely to avoid a government shutdown. Meanwhile, growing federal deficits threaten price stability, the dollar and, ultimately, economic competitiveness.
Despite the real risk of fiscal insolvency, Republicans and Democrats have been competing over who can cut more non-defense discretionary spending in an exercise of messaging rather than substance. With his new budget proposal, Rep. Paul Ryan appears to be one of the few leaders willing to risk their careers by tackling entitlement and defense spending, political third rails that must be addressed.
In such an environment, can the panel created by Dodd-Frank even play a role in addressing systemic risks?
The FSOC is chaired by the Treasury secretary, and its 15 members — 10 voting and five nonvoting — include an insurance expert and the heads of the major independent federal regulators: the Federal Reserve, the Securities and Exchange Commission, the Comptroller of the Currency, the Federal Deposit Insurance Corp., the Commodity Futures Trading Commission and the Consumer Financial Protection Bureau.
Over the past century Congress has recognized the importance of keeping financial regulators independent of politics. Most agree that election results and polls shouldn’t affect, say, the Federal Reserve’s stance on monetary policy or the FDIC’s assessment of a bank’s safety and soundness. Regulators have fought hard to strengthen their independence.
So the FSOC already has a conflict. The Treasury secretary is not an independent regulator: He is a member of the president’s Cabinet and the chief economic spokesman for the executive branch. In the Banking Act of 1935, Congress decided that the Federal Reserve’s independence needed to be strengthened and restructured its governance; actions included removing the Treasury secretary from the board, on which he had served as chairman. As a former regulator, Treasury Secretary Tim Geithner understands the importance of regulatory independence. As he establishes the nascent council as the watchdog for U.S. financial stability, Geithner has an opportunity to institutionalize its independence from administration politics by enabling the FSOC to tackle important issues even if they are politically inconvenient for the president. Each member of the FSOC should be empowered to identify and direct the staff to analyze potential systemic risks.
An FSOC that is independent of political considerations could provide important cover for frightened politicians by dispassionately assessing and reporting the risks we face from out-of-control deficit spending. Regarding the deficit, the council could do this without recommending a specific budget proposal, neither endorsing nor challenging the president’s budget. And given the council’s origin, lawmakers should pay attention to its assessments and recommendations.
The FSOC should immediately analyze and report to the American people the systemic implications of out-of-control deficit spending and the economic consequences of a U.S. default. Such a scenario is the largest threat to U.S. financial and economic stability, and the FSOC should call on the legislative and executive branches to act urgently — certainly before the next election. Congress passed the extremely unpopular TARP legislation in the fall of 2008 just two weeks after then-Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke explained the risks of a financial collapse and called on Congress to act. The FSOC could be a catalyst for action on the deficit.
Geithner has an opportunity to establish the FSOC’s independence and scope and, in doing so, increase its effectiveness as a systemic risk regulator. Defining the systemic risks from growing deficits could bolster public support for making hard fiscal choices while strengthening the FSOC’s credibility as a serious, independent watchdog for U.S. economic stability.
The writer, a managing director of the investment management firm PIMCO, served as an assistant Treasury secretary during the George W. Bush administration. He led the Office of Financial Stability and ran the Troubled Assets Relief Program until May 2009.