Listening to Ben Bernanke last week, you'd think the Federal Reserve was in for a shakeup that would eviscerate the central bank's ability to keep a handle on the U.S. economy.
Speaking about Senate Banking Committee Chairman Christopher Dodd's financial reform plan, which would strip the Fed of huge portions of its bank supervision duties, the Fed chairman told lawmakers that robbing the Fed of supervision duties for all but the biggest banks would leave the central bank with far less than the complete view of the economy it needs to conduct monetary policy appropriately. Dodd, D-Conn., plans to hold a committee vote on his bill beginning March 22.
"The insights provided by our role in supervising a range of banks, including community banks, significantly increases our effectiveness in making monetary policy and fostering financial stability," Bernanke told the House Financial Services Committee.
His comments ring with the desperation of a powerful person about to lose some turf. But the truth is, in this deal the Fed would lose a little and gain a lot when it comes to the job the Board of Governors cares about most -- managing the overall economy. Though the Fed would lose its position as primary regulator for nearly 6,000 banking institutions, it would gain broader new tools to shape the overall tenor of the economy. In addition to setting monetary policy, the Fed would become the primary regulator of any financial company that presents a risk or plays a critical role in the financial system. That's in addition to retaining its current authority over the largest bank holding companies. The Fed also would be assigned to set new rules for capital, leverage, liquidity and risk management that would grow more strict as the companies grow in size.
Finally, the Fed would become the designated guardian of consumers in their dealings with credit card companies, banks, mortgage brokers and other sellers of financial products.
Currently, the Fed regulates 5,000 U.S. bank holding companies and about 850 state-chartered members of the Federal Reserve System. Under Dodd's bill, the responsibility for commercial banks would be narrowed to the 55 bank holding companies with assets greater than $50 billion.
Given the Fed's diminished reputation in the wake of the financial crisis, perhaps Bernanke ought to be grateful for the deal he's being offered. Of all the federal financial agencies, the Fed is the one that stirs up the strongest feelings among Americans. Since its founding in 1913, the Fed has been the favorite target of conspiracy theorists, gold standard fanatics and many Americans who are simply suspicious of any institution that shifts power to the central government.
That historic ambivalence has been intensified by the Fed's role, both real and perceived, in the crisis. By Bernanke's own admission, the central bank ignored the run-up in poorly underwritten subprime loans. Fed critics also argue that the housing bubble was driven by the central bank's efforts to prime the economy with near-zero interest rates, an assertion Bernanke rejects. Wariness of the Fed is more widespread than ever, and in such an environment, Bernanke is going to have to accept a major reordering of the Fed's duties.
Laura Corsell, partner with Montgomery, McCracken, Walker & Rhoads LLP in Philadelphia and a former staff attorney with the Security and Exchange Commission's investment management division, says the overhaul of the Fed's duties makes sense -- except for the assignment of consumer protection.
By forcing the Fed to focus on macroeconomic regulation -- monetary policy, payments systems and the most systemically risky firms -- and handing off basic bank regulation to the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency, the Dodd bill would bring order to the patchwork of U.S. bank regulation, she says. It's a sensible compromise between those who want to combine all four federal regulators into a single agency and those who want to maintain the status quo.
"This is part of the tug and pull between the big oversight czar model and one in which we have more independent and nimble smaller regulators," she says. Corsell argues that, just as many people argue that the too-big-to-fail financial firms should be downsized, "maybe the regulators should be broken down into pieces too."
Corsell suggests that Dodd's plan for creating a systemic risk council of all the regulators can assist the Fed in gathering the industry intelligence it needs. "The risk council can be the forum for just that type of communication."
As for consumer protection, however, giving the job to the Fed is a "questionable move," Corsell says. "The Fed is supported by a tithe from the banks," she says. "I wonder if that does give banks more input on policy than they should have."
Dodd's reordering of the Fed may be nothing more than a Hail Mary attempt to strike a political compromise where there is no easy solution. No agency is the clear home for many of the new powers being created, and no financial regulatory agency is blameless in the financial meltdown.
Judging from the comments of Lawrence Summers, chairman of President Obama's National Economic Council, that appears to be the view in the White House. Summers said March 18 at the National Press Club that the primary aims of reform should be to impose capital and liquidity levels, constrain risks and ensure failures of the most systemically important firms can be managed.
As for how to divide the duties: "There is no silver bullet for getting at too-big-to-fail," he said. "Turf is the easiest to debate and generates the most excitement but what is most important over time is whether we adopt elements of a program ... that really gets at something that is fundamentally threatening to the market."
Even the lawmakers ironing out the bill's details appear less concerned about dividing duties than they are about the many more basic issues that remain unresolved or unaddressed. For instance, Sen. Bob Corker, R-Tenn., a central player in the Senate negotiations, lamented that with the committee vote approaching, the bill as of yet contains no section dealing with underwriting and securitization -- core causes of the recent crisis. Corker said there has been no discussion of limiting subprime securitization. "Why should we allow securitization of subprime loans in the first place?" he asked. Originators would stop writing loans with terms borrowers cannot conceivably repay if the lenders had to keep those loans on their books, Corker said.
Nevertheless, Corker predicted that the Fed won't stop its fight to limit encroachments on its turf. Another possible complaint from the Fed is likely to be lawmakers' attempt to break down the barrier limiting regulators' ability to examine affiliates of insured banks. Primary bank supervisors too often have difficulty examining operations of subsidiaries if they are controlled by the parent holding company, he said.
That's because bank supervisors such as the OCC are limited to examining a depository institution itself and face a closed door if they suspect the bank could be affected by problems at a subsidiary controlled by the bank's parent company, which would be the purview of the Fed. The Senate bill would allow the OCC and the FDIC to open that "closed door." Says Corker: "That probably will receive attention from the Fed."