Should the systemic risk regulator be the Fed?

by on June 18, 2009 at 7:28 am in Economics | Permalink

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.

1 MikeDC June 18, 2009 at 8:28 am

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”.

2 mickslam June 18, 2009 at 8:57 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.

3 babar June 18, 2009 at 9:30 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”

4 Leonid June 18, 2009 at 10:13 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.

5 Andrew June 18, 2009 at 12:27 pm

“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.”

6 Alan Brown June 19, 2009 at 3:56 am

The Fed creates systemic risk. So how can it be expected to regulate it?

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