Economists: Bad Idea Making Fed A Super-Regulator

Posted In: Bank Failures, Bubbles, Central Banks, Congress, Economists, Economy, Federal Reserve, Financial Markets, Financial Sector, Obama Administration, Politicians, Re-Regulation, U.S. Government

I already knew the Obama administration’s proposal to grant additional regulatory powers to the Federal Reserve was a horrible, misguided idea.

I mean, who in their right mind would propose to make the Fed responsible for reining in “systemic risks” in the financial system when the evidence shows it has been unable to identify and prevent such threats time and time again?

However, don’t take my word for it. From the New York Times’ Edmund Andrews this morning:

Two economists with longstanding ties to the Federal Reserve warned Congress on Thursday that it would be a mistake to make the Fed a super-regulator in charge of reining in “systemic risk” and financial institutions considered “too big to fail.”

In what is shaping up as a political battle over a crucial part of President Obama’s plan to overhaul financial regulation, the economists told a House panel that the Fed had consistently failed to recognize financial catastrophes until they were well under way.

“I do not know of any single clear example in which the Federal Reserve acted in advance to head off a crisis or a series of banking or financial failures,” said Allan H. Meltzer, professor of political economy at Carnegie Mellon University and the author of a history of the Fed.

In written testimony prepared for the House Financial Services Committee, Mr. Meltzer ticked off a long list of financial crises — the Latin American debt crisis of the 1980s, the savings-and-loan collapse of the early 1990s, the collapse of the dot-com bubble and the recent binge in reckless mortgages — and argued that the Fed had either failed to take preventive action or made things worse.

“We all know that the Federal Reserve did nothing to prevent the current credit crisis,” Mr. Meltzer said. “It has not recognized that its actions promoted moral hazard and encouraged incentives to take risk.”

A broader warning came from John B. Taylor, a top Treasury official under President George W. Bush who was considered a potential candidate to succeed Alan Greenspan as Fed chairman.

Mr. Taylor said that expanding the Fed’s power would dilute its main mission of steering the economy, create conflicts of interest, reduce its credibility and jeopardize its independence.

“The administration proposal would grant to the Fed significant new powers, more powers than it has ever had before,” he told lawmakers. “My experience in government and elsewhere is that institutions work best when they focus on a limited set of understandable goals.”

The Obama administration is proposing to make the Fed responsible for identifying and reining in “systemic risks,” like the explosion of reckless mortgages that nearly destroyed the financial system and started a recession that has yet to hit bottom.

The Fed would also be in charge of regulating giant financial institutions that are considered too big to fail, perhaps by imposing higher capital requirements on them.

But the proposal is highly controversial. Banking and Wall Street executives generally support the idea, as do current and former officials at the Fed and some Democratic lawmakers, like Representative Barney Frank, chairman of the House Financial Services Committee.

Source:

“Two Authorities on Fed Advise Congress Against Expanding Its Power”
Edmund L. Andrews
New York Times, July 10, 2009

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