Top regulators want a council, not the Fed, to lead in supervising systemic risk

Exclusive analysis for FinReg21 by Darrell Delamaide

The battle for who will be top dog in systemic risk supervision seemed to tilt this week against the Federal Reserve as other regulators pressed their case for giving a council of regulators the decisive power in monitoring and dealing with potential threats to the financial system.

With Fed chairman Ben Bernanke on the defensive on several fronts, two top regulators – FDIC chairman Sheila Bair and SEC chairman Mary Schapiro – made common cause to endow the administration’s proposed systemic risk council with greater authority, including an independent chairman.

In a flurry of congressional hearings over the past week, there seemed to be little objection among existing regulators to expanding the Bank Holding Company Act to include other types of financial holding companies that are systemically important. These would then come under the Fed’s supervision as prudential regulator.

Likewise, there seemed to be universal acceptance of the need for an expanded resolution authority, so that the government can seize and unwind large financial holding companies in the way that the FDIC currently resolves problems at failing depository institutions.

The controversy revolved around who will have the primary responsibility for identifying and dealing with systemic risk, and that’s where several of the regulators parted ways with the administration.

While the government’s white paper includes a systemic risk council made up of the main financial regulators in a consultative role, the administration maintains that the main systemic risk regulator should be a single, accountable authority that can act quickly in a crisis.

But Bair and Schapiro made the argument that effective systemic supervision needs to draw on the full panoply of financial regulators.

“The macro-prudential oversight of system-wide risks requires the integration of insights from a number of different regulatory perspectives – banks, securities firms, holding companies, and perhaps others,” FDIC’s Bair said in Senate testimony on Thursday. “Only through these differing perspectives can there be a holistic view of developing risks to our system.”

Bair dismisses the notion that a committee cannot act decisively enough in a crisis, citing her experience with the FDIC board, which includes other banking regulators and can often act overnight to resolve a bank failure.

Lawmakers, meanwhile, are openly skeptical of granting the Fed any additional authority. Rep. Paul Kanjorski (D-Pa.), the second-ranking Democrat on the House Financial Services Committee, reiterated his reservations on this score in his opening statement at a hearing Friday.

The SEC’s Schapiro accepts the designation of the Fed or a newly created agency as a systemic risk supervisor, but argues that the proposed systemic risk council “must be strengthened beyond the framework set forth in the administration’s ‘White Paper.’”

Schapiro said that the proposed systemic risk council “should have the tools needed to identify emerging risks; be able to establish rules for leverage and risk-based capital for systemically-important institutions; and be empowered to serve as a ready mechanism for identifying emerging risks and minimizing the regulatory arbitrage that can lead to a regulatory race to the bottom.”

At the House hearing on Friday, Treasury Secretary Timothy Geithner portrayed the new authority for the Fed as an organic extension of its current authority. He also emphasized that the government’s reform plan takes away some of the Fed’s current responsibilities, notably in the area of consumer protection on mortgages and credit cards.

Also testifying at the House hearing on Friday, Fed Chairman Bernanke likewise downplayed the scope of the change envisaged in the reform plan.

“While the improvements in the financial regulatory framework…would involve some expansion of Federal Reserve responsibilities, that expansion would be an incremental and natural extension of the Federal Reserve’s existing supervisory and regulatory responsibilities,” he said. “While this proposal is an important piece of an agenda to contain systemic risk and the too-big-to-fail problem, it would not actually entail a significant expansion of the Federal Reserve’s mandate.”

In her call for a systemic risk council “with real teeth,” Bair argued that it should not be chaired by the Treasury secretary, as in the administration’s proposal, but should have an independent chairman appointed by the president to avoid politicizing regulation.

“In designing the role of the Council, it will be important to preserve the longstanding principle that bank regulation and supervision are best conducted by independent agencies,” Bair said. “Consideration should be given to a configuration that would establish the chairman of the council as a presidential appointee, subject to Senate confirmation.”

Sen. Mark Warner (D-Va.), who opposes making the Fed the chief systemic risk regulator, has similarly proposed an independent chairman for a council solution, as well as a dedicated staff.

The discussion of a systemic risk regulator is bound up with the other major initiative in the administration’s proposal – the creation of a Consumer Financial Protection Agency.

Secretary Geithner noted in his Friday testimony that existing regulators had reservations about the new agency, which he said was a natural reaction of any agency keen on preserving its powers. But he insisted that the failure of existing agencies to provide adequate protection against abuses in mortgages and credit cards made the new agency necessary.

FDIC’s Bair, who also testified at the House hearing on Friday, expressed her support for the new agency, but rejected the notion that examination staff should be moved from the FDIC or other regulatory agencies to staff the new body.

Bair’s equivocal support for the proposal, after reports of her opposition behind the scenes, suggests a possible compromise for the administration as it bucks industry and Republican opposition to the new consumer agency. The administration may have to give ground on the primacy of the Fed in monitoring systemic risk in exchange for broader acceptance of the consumer agency by existing regulators.

The CFPA proposal suffered a setback earlier in the week when House Financial Services chairman Barney Frank put off a committee vote on the measure until after the August recess, noting that it had generated more controversy than he had anticipated.

Several committee members made their opposition to the consumer agency clear in their remarks and questions on Friday, as they worried that the agency would stifle innovation and limit consumer choice.

The Obama administration will need allies if it wants to make the CFPA a reality and it may need to yield ground on the expansion of the Fed’s authority in order to win them.