Experts divided on Fed role in monitoring systemic risk, cautious on consumer agency

In what may be a preview of the debate in Congress, regulatory experts diverged sharply over the administration’s proposal to have the Federal Reserve regulate systemically important institutions.

In a FinReg21 virtual roundtable moderated online by editor in chief David Evans, two of three experts labeled the expanded Fed role a “bad idea” or a “completely bad idea.”

Only Robert Litan, a fellow at the Brookings Institution, thought the designation of the Fed to monitor these institutions was the preferable choice, given the realistic alternatives. There was little chance of the ideal solution, a completely new agency to monitor solvency of all financial institutions. A council of regulators, he argued, echoing administration officials, would not get the job done because there would be no accountability and failure would just lead to finger-pointing.

Lawrence White, a professor at New York University, said that the Fed has too much on its plate already with managing monetary policy. Moreover, the central bank “did not cover itself with glory” in discharging its current regulatory responsibilities ahead of the financial meltdown. A separate agency would be a better choice, he said.

No one should have the role of deciding which institutions are systemically important, contended Peter Wallison, a fellow at American Enterprise Institute, because designating certain institutions as too important to fail creates too much moral hazard. What might be useful, he said, is a process to take an overview of the entire financial system and watch for dangerous trends, and that would be best performed by a council of regulators with a strong chairman.

In a wide-ranging discussion on the government’s white paper on regulatory reform released earlier this week, the three experts also expressed varying degrees of caution about the proposed Consumer Financial Protection Agency.

Will it be more like the Federal Trade Commission and identify products that need to be withdrawn because they are hazardous, or more like the Food and Drug Administration, which must test and approve all drugs before they are allowed on the market? The details offered by the white paper don’t make this clear, the panel said.

Or, worried Wallison, would the panel in the end be dictating that certain products could not be offered to certain people because they are not sophisticated enough for them. A ruling to that effect by the agency would expose the originators of that product to civil liability and would mean that some people could not get products they might like to have.

At the other end of the spectrum would be an agency that simply approved disclosure and marketing materials for financial products, panelists suggested.

Despite the uncertainty, however, the proposed agency is likely to be enacted in some form, Litan said, because so many Democrats are interested in the idea. Wallison disagreed because he thought that an agency which deprives consumers of choices to that extent is not “the kind of society we want.”

NYU professor White said the government took some wrong turns in its proposals. For one thing, he said, it talked about stricter regulation of credit rating agencies rather than de-emphasizing their role in credit markets. For another, it aimed to eliminate the one existing charter for industrial loan companies that would allow Wal-Mart and other commercial enterprises to operate a financial institution.

The experts did agree on one thing – that there was little chance of the package being enacted by Congress by the end of this year, as Democratic leaders have promised. Especially with major legislation on healthcare reform and climate change in the pipeline ahead of regulatory reform, it is much likelier that most of the legislation would not be finished until 2010.

Besides, noted AEI’s Wallison, the independent commission authorized by Congress to examine the causes of the crisis, which has not even been appoint yet, will only have its report finished by the end of the year.

Listen to the discussion

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