President Obama is releasing details of his plan for overhauling the financial regulatory system. It’s being widely reported that they were developed with help from the very same people that got us into this mess. Not surprisingly, they won’t do anything to address the fundamental dysfunction in our financial system that lets banks grow so big and politically powerful that they they can take down our economy, but still get rescued with money form the taxpayers whose jobs and houses they have put in jeopardy.
The Obama Administration wants to turn the Federal Reserve into the country’s financial supercop in charge of deciding when a corporation has become too big to fail and poses a risk to the rest of the economy. Most of Congress, and others like the FDIC’s Sheila Bair, are against the idea. They would rather create a new systemic risk council made up of regulators from a variety of agencies, including the FDIC, the SEC, the Treasury, the Fed and others.
Skepticism of the Fed has been growing ever since the economic crisis began. The central bank has been putting up incredible amount of taxpayer money — somewhere in the range of $4-9 trillion — in various efforts to stave of the crisis. But, under U.S. code, the Fed is specifically exempted from government audits, so nobody actually knows where any of that money has gone or how much of it taxpayers will be getting back. Compounding the issue is the fact that the Fed, a quasi-government agency, has on its board representatives from all of the country’s biggest banks, making it especially ripe for the kind of mind-set corruption that made them blind to the system risks building up in the markets before the meltdown.
The Fed shouldn’t be a systemic risk regulator. They don’t deserve the power, and neither does any other regulatory council that Congress could dream up.
Why should we think of systemic risk as a subjective question? Why not develop a hard-and-fast set of rules to define a too-big-to-fail bank? If a bank qualifies under the rules, they should be broken up into smaller banks and shareholders should be given shares in the new companies.
Author and former investment banker John Talbott has even suggested some numbers for this. He proposes that any financial company that become “larger than $100 billion in market capitalization, including its debt, or attains greater than $300 billion in assets” should be considered to pose a systemic risk and should be dealt with appropriately. The exact numbers, of course, can be worked out with empirical research. I could see, for example, the cap on size being proportional and adjustable to the size of the financial markets overall.
This kind of scale-based policy has several advantages. First, it promotes competition by keeping financial markets free of monopolistic powers. Second, it would make the financial-services industry more stable by encouraging more small and medium sized banks instead of concentrating power in a few big ones. Third, it precludes unnecessary government meddling in the free market. A fourth advantage, which is actually a feature of the third, is that a hard-and-fast too-big-to-fail rule would keep closed a new avenue for collusion that would be created by a systemic-risk regulator. Giving regulators new power to pick winners and losers among the nation’s biggest banks would amplify the pay-to-play system and make government even more responsive to corporate money. Scale-based policies would keep things objective.
There has been a lot of talk among economists recently about regulatory capture as one of the key contributors to the “too big to fail” situation. When making a new policy specifically for dealing with the biggest of the financial corporations — the ones with the most resources for currying favor with policy makers and regulators — it just makes sense to construct them so that they are resistant to industry influences.
The idea of a systemic risk regulator is just smoke and mirrors. It’s one way of making it sound like they are taking care of root causes of the bailout without having to inconvenience the big banks they’ve spent the last six months looking out for. No doubt, Obama will or must be pushed to come out with bolder ideas to address root causes. What makes the Obama Administration think that the same people who failed to see any systemic risks before the crisis will suddenly become the nation’s foremost experts on the matter just because they have been re-labeled “systemic risk regulators”?