Too Big To Fail, Part I: Oversight Council

The new 'too big to fail' legislation is too big to analyze in one post. It would have to be several thousand words. But it's also too important to ignore. I don't think any other regulatory rules enacted will be as important to prevent future financial crises. So I am going to focus most of the day today on reading through the 253-page draft (opens .pdf) released yesterday, titled the Financial Stability Improvement Act of 2009. I'll provide some highlights and analysis from the major sections in separate posts. I'll start with the proposed Financial Services Oversight Council.

Members

The proposal seeks to create an oversight council to supervise financial firms so large that their failure poses a systemic risk to the financial system. Here are the proposed voting members:

- Secretary of the Treasury, who will serve as the Chairman of the Council
- Chairman of the Fed
- Comptroller of the Currency
- Director of the Office of Thrift Supervision (until the director's functions are transferred pursuant to the proposal)
- Chairman of the Securities and Exchange Commission
- Chairman of the Commodities Futures Trading Commission
- Chairperson of the Federal Depository Insurance Corporation
- Director of the Federal Housing Finance Agency
- Chairman of the National Credit Union Administration

Just for the record, the FDIC's representative is the only one the bill lists as "chairperson" instead of "chairman." Presumably they have current Chairperson Sheila Bair in mind. I assume this doesn't preclude that future members in those other slots could also be women.

Nonvoting members include a rotating advisor from the state insurance commissioners and another rotating advisor from the state banking supervisors.

This list seems pretty thorough. I like the diversity of the group and that it appears to bring a good spectrum of knowledge to the table. I'm also relieved that this power isn't given entirely to the Fed.

Duties

So just what will this council do?

- Advise Congress on regulation and financial stability
- Monitor the market to detect threats to stability
- Identify systemically relevant firms for heightened oversight
- Issue formal regulatory recommendations to member agencies
- Facilitate information sharing among member agencies
- Act as a forum to discuss new market trends
- Resolve jurisdictional or regulatory disputes among member agencies

Additionally, it can appoint working groups to handle specific issues it's dealing with. The committee also must report to Congress annually, but the Treasury appears to have most of the power to create permanent staffing and handle logistics.

These duties all seem relatively harmless. With that said, I remain unconvinced that such a council would have prevented the financial crisis. The second bullet point above -- monitoring the market for potential threats -- would be where prevention might have occurred. But without a crystal ball, it couldn't have seen what was coming. The whole problem with unforeseen risk is that it's, well, unforeseen.

But that doesn't mean the council is useless. I think it's good to have a council of experts advising Congress on regulation. If you've ever watched a Financial Services Committee hearing, then you'd probably agree that it could use all the expert help it can get. I also like that the council will work together to issue formal recommendations for member agencies. That way, their rules won't be created in a vacuum. It also can't hurt for these agencies to have a forum to share information and discuss the market periodically. Finally, I really like that there's a functionality to resolve agency disputes. I'd hope that this would make for less regulatory overlap and arbitrage opportunities.

The aspect of the council that bothers me a little is its deciding which firms are systemically relevant. This is also arguably its most essential function, since this proposal seeks to regulate these firms differently from others. I'm not crazy about such distinctions being made among firms, but I'll get into this worry more later when dealing with this aspect of the legislation more specifically.