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Should the systemic risk regulator be the Fed?
Kevin Drum says no:
If you're going to create some kind of system risk regulator at all — about which I'm sort of agnostic in the first place — you want to give the authority to an agency that's institutionally dedicated to reducing risk and considers it a primary task. That ain't the Fed. It's just going to get buried in the bureaucracy and forgotten there.
Assuming we are going to do it, I think it has to be the Fed, whether we like it or not. It's the Fed who is the fireman with the awesome power to print money, move markets, lend to the banking system on a large scale, and now even conduct fiscal policy, all without Congressional approval. Our textbooks speak of the Fed as a lender of last resort but very often it is the lender of first resort too.
If you stuck another agency into that mix, it would end up waiting for the Fed's go-ahead, once an actual crisis arrived.
OK, so the systemic regulator is the Fed. But then you can't make the systemic regulator too accountable to Congress without eliminating the quasi-independence of the central bank. There's not any comfortable point on the power-accountability continuum, mostly because we don't trust Congress to run monetary policy.
The stinger on the tail is this: we want the Fed to deliver low inflation. That means we let it be influenced by financial creditor interest groups but not so much by populist interest groups (Adam Posen had a good piece on this but I cannot recall the reference). Right now a lot of people are asking for more populist regulation without realizing that also requires more populist monetary policy.
It's very hard to get financial regulation right. It's the populist stuff that Obama wants to strip into a separate agency (for consumer protection) but it is difficult for such an agency to cover the major elements of systemic risk.
Posted by Tyler Cowen on June 18, 2009 at 07:28 AM in Economics | Permalink
Comments
Our textbooks also point out that the explicit mission of the Fed was to prevent bank panics and consequent recessions, and thus to promote economic growth.
That is, in the language and context of 1913, it was set up to prevent "systemic risk".
Posted by: MikeDC at Jun 18, 2009 8:28:03 AM
It would be like putting the fox in charge of egg production.
Posted by: AADL at Jun 18, 2009 8:46:36 AM
The Fed has done a pretty good job at preventing panics. We've only had 2 under their watch in almost 100 years. Prior to that, panics were a common feature of the U.S. economy.
I disagree with this: "with the awesome power to print money,..." The fed doesn't print money. It controls the interest rate associated with money, not the quantity. The quantity is controlled by the U.S. congress.
Posted by: mickslam at Jun 18, 2009 8:57:38 AM
Isn't there an easy joke in here about the fox guarding the hen house? ;-)
Posted by: Speedmaster at Jun 18, 2009 9:00:47 AM
how about a PSA campaign?
posters on bus shelters and ads on TV.
"if you take a loan you can't repay, you may be spreading SYSTEMIC RISK"
"someone offer you a mortgage that seems too good to be true? say something."
"contentment is the new extravagence: live in the house you can afford"
Posted by: babar at Jun 18, 2009 9:30:11 AM
So, basically, to paraphrase:
"In response to this recent crisis, the Fed will become a new systemic regulator, because they've done such a great job in the past with this new responsibility"
Posted by: Andrew at Jun 18, 2009 9:47:49 AM
Why do we ask questions about how to regulate "systemic risk", as opposed to asking the question of why it exists (assuming that we can agree on a definition) in the first place? Does Exxon pose a "system risk" ? Should we regulate them in case they produce too much gasoline.
Posted by: Leonid at Jun 18, 2009 10:13:06 AM
I am a bit surprised that Tyler thinks the solution is an activist Fed. Do you want a rapid response Fed responding to every fire in the financial system, regardless of how isolated or trivial to the macroeconomy, or do you want a Fed that concentrates on maintaing stability in the system.
If the Fed responds to every flare up, they must become more political. Regional interests or special interests politics will pull on the Fed to solve problems that are best left to the marketplace to solve.
Do we want a repeat of the S & L crisis i.e. S&L owners helped manipulate the regulatory system to insure against loses while allowing them to keep gains. This lead to a very predictable result, excessive risk taking. (Although the Fed created inflation may have done more to damage the S&L's then anything else.)
The Obama view is that free market capitalism is intrinsically flawed. I understand why Obama wants to change capitalism, it doesn't think it distribute rewards in a way that he thinks is equitable. Free markets build cars he doesn't like, deliver health care in ways he disagrees with, and generates wealth for people who don't deserve it. I just wish Obama would quit lying and admit that he prefers democratic socialism.
I also understood that Krugman thinks that the vast uneducated masses must be lead by elites controlling the economy in the best interest of the deserving.
But I am surprised that Tyler Cowen seems to share the view that financial markets must be regulated to function.
Posted by: DanC at Jun 18, 2009 10:42:43 AM
"While the plunge protection team has never existed, it has prevented all the plunges that never occurred, therefore, they will be reinstated for the prevention of future plunges that are within their statutory authority to prevent. They will be indentified by their orange t-shirts indicating the orange status of systemic risk on the simple color scale borrowed from DHS."
Posted by: Andrew at Jun 18, 2009 12:27:34 PM
I would like the risk be managed by the financial institutions by mutua insurance.
Create the legal authority for a super FDIC with Fed backing for the fund. The law would require insurance fees sufficient to repay external losses requiring Fed bailout in three years, while losses between members would be allowed ten years to repay.
Once a member, the member submits to the insurers risk management rules, and the institution can never leave, except by liquidation. As a member, the institution gets a backed by full faith and credit seal. All other financial contracts over a certain size would require a seal of "small enough to fail".
The insurer would be governed by the members (one vote each) with the Fed having the authority to step in and act if the regulator administrator ended up in a deadlock because its members won't act. Decisions should have a super majority to ensure concensus and prudence. Each meeting would be opened with "if we can't agree, the Fed will take over."
The problem with FDIC is it protects only depositors, not bank trust for all bank securities, and Congress sets the regulation and fees, often yielding to lobbiests and leaving it unsound.
Make the big institutions insure themselves mutually with it being clear to all, especially the small members, that letting the big guys do stupid stuff could mean its foolishness will cost them big time. My guess is the big banks will find themselves constrained by the small banks to a much greater extent than the Fed or any other regulator could manage in their political environment.
Posted by: mulp at Jun 19, 2009 3:23:38 AM
The Fed creates systemic risk. So how can it be expected to regulate it?
Posted by: Alan Brown at Jun 19, 2009 3:56:40 AM
It's very hard to get financial regulation right.
Yes, and we have arguably been trying since AT LEAST 1887, when the Interstate Commerce Commission was created to regulate the railroads, and certainly since 1933 and we really still haven't completely swallowed Sarbanes Oxley-which was supposed to protect the "integrity" of our capital markets.
But we have Oak from ACORN Obama and his faithful companion Turbotax Timmy Geithner and the Countrywide Chris Dodd and Brothel Barney Frank in charge now; by golly I just know we'll get it right now!!!! I really do, I believe in hope and change.
Right after that 31 year old, no experience dropout brings GM back from the grave.
Posted by: Phil at Jun 19, 2009 1:15:47 PM
good informative
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Posted by: sohbet at Jun 20, 2009 11:02:38 PM
A Fiscally Responsible Alternative to the Obama Healthcare Plan (Abstract)
Strategic Studies Group www.TheJISSCorporation.org
Fiscally Responsible Healthcare
Diversification and Expansion of Health Insurance Premium Payment Plan (HIPPP)
The Health Insurance Premium Payment Plan is an innovative initiative that has already been successful in generating a substantial amount of income that has been used to offset expenditures in the Medicaid program and is indicative of what can be achieved with a more cost efficient, diversified and expanded version of the same. By funneling over 40 million healthcare seeking Americans through the HIPPP branch of Medicaid, the Obama administration would create a scenario where the Medicaid program would become a profitable entity that pays its own way for the most part with even the most nominal displays of tangible participation with HIPPP copayment terms. The following benefits would soon follow:
1. The need for over 300 billion in proposed tax increases that was proposed under the Obama Healthcare Plan would be eliminated.
2. The need for the 600 billion healthcare “expansion” fund will be eliminated.
3. The allocation support ratio (ASR) would be exponentially reduced in regards to federal and state funding of the Medicaid program, therefore, freeing up billions of dollars that can be redirected to programs that are in desperate need of augmentation.
4. The diversification and expansion of the HIPPP would become a stabilizing factor that would immediately force private insurers to institute price controls on private healthcare insurance in order to remain competitive with the HIPPP. This occurrence would save Americans billions of dollars in healthcare related premiums and copayments.
5. A scenario where Americans participate in the HIPPP would exponentially expand healthcare coverage while giving the Obama administration the governing body mandate and oversight they need to ensure morally acceptable conduct and fiscal accountability by members of the healthcare industry and the Medicaid program as a whole.
Note:
"Crisis Related Reasons Why the Economic Stimulus Package May Fail" (Strategic Studies Group)
is available at www.TheJISSCorporation.org
Posted by: CEO at Jun 23, 2009 9:43:37 AM
5. A scenario where Americans participate in the HIPPP would exponentially expand healthcare coverage while giving the Obama administration the governing body mandate and oversight they need to ensure morally acceptable conduct and fiscal accountability by members of the healthcare industry and the Medicaid program as a whole.
Posted by: su deposu at Nov 20, 2009 9:05:19 AM
