Bernanke Sends Mixed Signals For Systemic Risk Regulation

Testifying before the House Financial Services Committee, Federal Reserve Chairman Ben Bernanke made a surprising assertion. He said that an oversight council should be in place to regulate the systemic risk of the U.S. financial system, rather than just the Federal Reserve. Some, including the Obama administration, have argued that the Fed alone should have this oversight authority, but the Chairman himself has now stated that he believes otherwise. Sort of. His testimony boils down to a mixed message.

Bernanke draws a distinction between "Consolidated Supervision of Systemically Important Financial Institutions" and "Systemic Risk Oversight." He believes the Fed should have sole responsibility for the consolidated supervision, but that a diverse panel of regulators should have oversight. The way to think of this is that the consolidated supervisor would handle all of the actual day-to-day work and rulemaking for systemically relevant firms. The oversight panel would attempt to identify new risk to the system, servicing a sort of big picture function.

Here is Bernanke on the consolidated supervisor:

The Federal Reserve is already the consolidated supervisor of some of the largest and most complex institutions in the world. I believe that the expertise we have developed in supervising large, diversified, and interconnected banking organizations, together with our broad knowledge of the financial markets in which these organizations operate, makes the Federal Reserve well suited to serve as the consolidated supervisor for those systemically important financial institutions that may not already be subject to the Bank Holding Company Act. In addition, our involvement in supervision is critical for ensuring that we have the necessary expertise, information, and authorities to carry out our essential functions as a central bank of promoting financial stability and making effective monetary policy.

This is sort of the same old song we've been hearing. The Fed has the ability to do it, so it's the logical choice. As I noted earlier in the week, however, just because the Fed is the easiest choice, doesn't necessarily make it the right choice. I've argued that there are strong reasons why the Fed might not be the best choice, despite its capability.

Here's his explanation of the oversight council:

First, an oversight council--composed of representatives of the agencies and departments involved in the oversight of the financial sector--should be established to monitor and identify emerging systemic risks across the full range of financial institutions and markets. Examples of such potential risks include rising and correlated risk exposures across firms and markets; significant increases in leverage that could result in systemic fragility; and gaps in regulatory coverage that arise in the course of financial change and innovation, including the development of new practices, products, and institutions. A council could also play useful roles in coordinating responses by member agencies to mitigate emerging systemic risks, in recommending actions to reduce procyclicality in regulatory and supervisory practices, and in identifying financial firms that may deserve designation as systemically important. To fulfill its responsibilities, a council would need access to a broad range of information from its member agencies regarding the institutions and markets they supervise and, when the necessary information is not available through that source, the authority to collect such information directly from financial institutions and markets.

Bernanke's suggestion looks like a compromise. He's becoming quite the politician. He seeks to have his cake and eat it too, where not only does the Fed get the authority to be the regulator, but the panel advocates are thrown a bone.

But I see it as little more than a bone -- unless that oversight council also has oversight to supervise the branch within the Fed that takes on systemic risk regulation. From what Bernanke's saying it's not at all clear that's the case. He paints the picture in such a way that the panel members would sort of work among themselves to close regulatory loopholes and predict risk -- not oversee any work of the Fed.

So long as the Fed has autonomy to regulate, all the potential criticisms for its getting the job follow. It still could fall prey to conflicts of interest; it does not need to get a second opinion on the actions it takes; and it might not place a high enough priority on this branch, since monetary policy is really its chief focus.

Again, if the panel had oversight over the systemic risk function of the Fed as well, then that would help. But I'm still unclear as to why the Fed should have the responsibility when instead the job could be given to a new agency with Congressional oversight and that sole focus.