Notes on Bernanke’s Vision of Fin Reg Reform
At the Council on Foreign Relations Tuesday, Fed Chair Ben Bernanke summarized four big ideas for financial regulation reform:
(1) too big to fail: tighter supervision of very large firms whose failure poses systemic consequences;
(2) infrastructure: strengthened infrastructure to trade, clear and settle novel financial instruments like credit default swaps and to stabilize money markets and commercial paper markets;
(3) accounting/regulatory: reform of requirements that exacerbate market swings (like accounting rules requiring valuing assets at prevailing market prices or capital requirements that prevent building capital reserves amid prosperity that can be absorbed amid adversity); and
(4) senior risk regulator: establishing a senior systemic risk authority to oversee all financial institutions at a macro level.
Popular press reports often concentrated on selected items, as with The New York Times report that allocated ¾ of the space to item (3).
More informed assessments appear in other media, especially David Zaring’s blog post at Conglomerate. (David’s summary reflects his and my thinking elaborated in our joint article on the subject, The Three of Four Approaches to Financial Regulation, shortly to be posted on SSRN).
Among the more notable and under-reported parts of the presentation was the follow up Q&A, especially the following colloquy between the Chair and my GW Law colleague, Steve Charnovitz, concerning item (4), the senior risk regulator:
CHARNOVITZ: I had a question about the systemic risk authority. As you’ve described it, it’s looking at financial institutions, financial instruments — really, the private sector. But shouldn’t an authority like that, if it’s going to be forward-looking and avoid financial crises, also look at the policies of the government — monetary policy, housing policy, trade policy, things like that? And therefore, shouldn’t this authority also be looking at the Federal Reserve, the Congress and the executive branch?
BERNANKE: Well, I think you’re — (chuckles) — you’re creating a number of conflicts of authority and power there. I mean, obviously, the Federal Reserve is independent in making its monetary policies. The Congress obviously cannot be managed by an authority that they create. (Laughter.) So I think, at best, that what the — what an authority could do would be to point out potential problems, and that the appropriate authorities — whether they be the Federal Reserve, the Congress, the administration — address them.
In particular, I do think that — more specifically, I do think that this crisis has revealed some rather shocking gaps in our regulatory oversight. I mean, who was overseeing the subprime lenders, for example? Who was overseeing AIG? There simply wasn’t enough adequate oversight in those cases. And it’s certainly one of the things that even a — even if you have an oversight financial stability authority which has a relatively light mandate — really, one just information gathering and description, rather than power, direct powers — an authority of that type could point out and identify such gaps and call them to the attention of the Congress, and Congress could then take the necessary steps.
So I think that you could have a part of the responsibilities of the systemic risk authority would be to try to identify problems of various kinds. But, you know, let’s be very clear. The ultimate authorities lie in — in the executive and legislative branches, and they would have to be the ones to decide how and whether to respond to issues that are raised by the systemic risk authority.