The Systemic Risk Council

I received this in an email today:

best approach to preventing future financial crises is through the
creation of a Systemic Risk Council —composed of at least the Fed,
Treasury, FDIC and SEC, according to William Isaac, former chairman of the Federal Deposit Insurance Corporation, and now chairman of Global Financial Services for consulting firm LECG.

To be sure, systemic risk is an important topic for regulators.  But the idea of a "systemic risk council" is much better than the idea of a Systemic Risk Council, all caps.  The more formal the institution, the greater its power to spook markets and become a source of systemic risk itself.  Let's say that an SRC were summoned into being and one day the Council warned that systemic risk was unacceptably high.  Economic activity would plummet and freeze up immediately and furthermore a liability issue could arise for any manager who did not shut down lots of plans.  The practical reality is that the Council would have to be very, very cautious in its statements and actions.  It's a bit like how the security alert these days is always on "Orange."  High enough to indicate some kind of warning and to protect the regulators from a charge of complacency, but not so high as to terrify everyone or indeed inform anyone.

I've heard some people argue that once the Council sees that systemic risk is too high, it will proceed silently and secretly, in Ninja-like fashion (my words, not theirs), to stamp it out by alerting other regulators about the problem.  I'm not convinced.

I am not arguing that we should simply stay put when it comes to financial regulation.  It would be good to limit forum-shopping, for instance, and also abolish the Office of Thrift Supervision and transfer its powers to the FDIC.  They are the group that dropped the ball on AIG, if you recall. 

The broader point is this.  Better regulation comes through many years of experience and gradual process improvements, built upon some reasonable methods for imposing regulatory accountability.  That's how the FDIC got to be good at much of what it does.  Better regulation does not come from sitting down, waving a wand, and hoping that a new name or box will address the problem you are concerned about.  Keep that in mind next time you hear that "now is the unique moment," etc.


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