One of the most important functions of last summer's massive financial regulation bill was to establish a council of regulators to monitor financial stability. The theory goes: if all regulators had met regularly last decade and discussed the economy, then they may have spotted the excessive risk building in the financial system and acted to reduce it before the storm hit. So that's what the newly established Financial Stability Oversight Council (FSOC) seeks to do. But was it poorly designed? Will its potential political bias render it worthless?
Before considering this question, it should be pointed out that the FSOC might simply not work anyway. Think back to 2005. Imagine regulators meeting and discussing the housing bubble. Let's say they even understood the rise of complex securities that investors and rating agencies didn't really understand. Let's say they worried that Fannie Mae and Freddie Mac were taking on too much risk. Would they really have had the will and confidence to criticize a seemingly thriving economy? And even if they had the will -- would they have been able to do anything to stop it? It's not at all obvious that the FSOC would have made a difference. But let's assume, for argument purposes, that they would have and could have prevented the crisis.
Is Politics an Obstacle?
In an op-ed today, former bailout supervisor and current PIMCO managing director Neel Kashkari argues that the makeup of the FSOC will prevent it from being successful:
So the FSOC already has a conflict. The Treasury secretary is not an independent regulator: He is a member of the president's Cabinet and the chief economic spokesman for the executive branch. In the Banking Act of 1935, Congress decided that the Federal Reserve's independence needed to be strengthened and restructured its governance; actions included removing the Treasury secretary from the board, on which he had served as chairman.
Taking a step back, here is the makeup of the voting members of the FSOC:
- Secretary of the Treasury (Chair)
- Federal Reserve Chairperson
- Comptroller of the Currency
- Consumer Financial Protection Bureau Director
- Securities and Exchange Commission Chairperson
- Federal Deposit Insurance Corporation Chairperson
- Commodity Futures Trading Commission Chairperson
- Federal Housing Finance Agency Director
- National Credit Union Administration Board Chairperson
- An independent insurance expert
For starters, you can see that the only overtly political member is the one Kashkari focuses on. The other nine are appointed heads of various financial regulatory agencies plus an insurance expert. So those other nine members are approximately as non-political as you can hope to get while still having the deep supervisory knowledge of their various financial subsectors needed to fulfill the council's purpose. Kashkari's criticism boils down to the Treasury Secretary.
Is this single member's presence there really that big of a problem? Sure, the Treasury Secretary is the chairperson, but he or she also only casts one vote. Since the committee's decisions are determined by majority rule, that isn't a great deal of political clout. Five other members have to agree with the Treasury Secretary to make that majority, and he or she does not have any sort of veto power if the other members approve a measure the chair disagrees with.
With that said, there could be an easy fix here: take away the Treasury Secretary's vote. He or she could still maintain chairpersonship without voting. That way, politics would be taken completely out of the equation, with the other nine members deciding on all action the committee takes.
The Deficit Problem
Kashkari actually frames his complaint with a very specific example. He asserts that the FSOC will not act to try to deal with the nation's deficit problem, due to the hopeless bias of the Treasury Secretary to uphold the White House's desire to ignore the problem.
For starters, current Secretary Geithner, as well as the President, understand that the current path of the deficit is unsustainable. So this criticism isn't entirely fair. It's more an issue of timing: Republicans want to begin cutting the deficit immediately, while Democrats would like to wait until the economy more fully recovers.
But let's place this quibble aside for a moment and consider a broader question that Kashkari's complaint raises: should the FSOC be worrying about the deficit? On one hand, if it continues to grow out of control, then it certainly could bring down the U.S. economy eventually. So isn't that a systemic problem? It might sound like one, but the deficit isn't an economic problem: it's a political problem.
Here are the sorts of things the FSOC should be looking out for: when risk is secretly building in the system, when regulatory mechanisms are failing, when a bubble is growing, when an economic shock may be looming. It's trying to identify cracks in the system and hidden problems. It has to connect the dots to see if dominoes are being set up to create a future crisis once a shock hits.
The deficit doesn't fit into that mold. It's actually a very simple problem. There's nothing hard to understand about what's going on here. The government is spending too much money without collecting enough taxes. Congress must either cut spending, raise taxes, or both. You don't need the ten greatest regulatory minds in the nation to point out that revelation.
Moreover, the FSOC can't really do anything to fix the deficit. It cannot force Congress to cut spending or raise taxes. It can issue a statement urging Congress to do so, but that isn't likely to go far. They already know that the deficit is a problem. They have already heard Fed Chair Ben Bernanke complain about deficits in numerous hearings. A statement by the FSOC will not suddenly provide Congress more political will power.
If the FSOC wants to issue such a statement about the deficit, then it certainly can do so. Its impact will probably be minimal, however. And there should be no time spent analyzing the deficit problem, because it's utterly straightforward. Instead, the FSOC should focus on potential problems that are less obvious that it can also have a greater impact by solving.