The Proposed Agency For Financial Stability

As mentioned earlier, I've begun tackling the Senate Banking Committee's mammoth systemic risk-targeted regulatory proposal (.pdf). The first section creates an "Agency For Financial Stability" (the "Agency"), which would function as systemic risk regulator. I want to compare and contrast this with the House draft's approach. Frankly, the Senate's version is better.

A New Agency

The big difference is that the Senate seeks to create an entirely new agency to take on systemic risk regulation. The House version provides most of this power to the Federal Reserve. I think the Senate has it right. Even though the Fed is well-equip to do the job of systemic risk regulator, I've argued in the past that just because it can perform this task doesn't mean it should.

I prefer an independent agency having this power, instead of the Fed, for two reasons. First, I worry about the Fed's dedication to oversight conflicting with its mission to promote banking. Second, I don't like that the Fed's lack of transparency could make some of its work as a regulator hard to assess by the public and Congress. The Agency the Senate seeks to create would clearly be subject to stricter oversight and avoid pro-banking bias.

Council vs. Board

The House version sets up a diverse council made up of various agency heads to have some powers, but as mentioned, the Federal Reserve ends up doing almost all of the actual regulation. In the Senate version, the Agency does all of that, but a similar board oversees the Agency.

Most of the participants on that board are the same people that would be on the council. The Treasury Secretary sits at the head of the House's council. But an independent head of the Senate's board, who also oversees the Agency, would be appointed by the President, and reigns for six years. I thought that kind of an odd choice for term length, so I'm not sure the motivation for that choice.

The Regulation

Like the House version, the Senate seeks to establish a list of firms who will be subject to heightened regulation. But unlike the House version, the Senate version appears to allow that list to be public. This was one major criticism of the House draft. It should be noted, however, that a potential amendment (.pdf) to the House version will be considered next week by the House Financial Services Committee that could change the privacy constraint.

The capital requirements, leverage requirements, etc. are all very similar in both versions of financial regulation. That is to say, both are relatively vague and just list the kinds of action that the systemic regulator should take, with few quantitative specifics. But even the categories of capital sufficiency the plans set appear to be almost identical. Of course, the major difference here is that the new Agency would set the specific requirements in the Senate version, instead of the Fed.


I know what you're thinking, "Okay, so there's gonna be this big new Agency that oversees financial risk. Who's gonna pay for it?" Not taxpayers. The draft indicates "permanent self-funding" by the new Agency assessing firms on its heightened regulation list to pay for its staff and expenses. Sounds great to me.

Resolution Plans

I am a strong advocate for the idea that these systemically risky firms should devise failure plans. The House's version requires this, and so does the Senate's. I'd give a slight edge to the Senate's draft here as well, however, as it also specifically requires the plan to include credit exposures. I think this would go a long way in determining how much a firm's failure would ultimately cost -- something that would be great to know beforehand, so that the potential failure can be paid for in a more proactive manner.

Break Up Authority

In the House version, there appears to be some authority for the Fed to break up firms that pose too much systemic risk and cannot be resolved without bringing down the financial system. But that authority is made clearer in the Senate's version and provided to the Agency instead. I think the Agency is a lot more likely to use that authority than the Fed, who also acts as an advocate for banking.

All in all, I prefer the Senate flavor for this aspect of systemic risk regulation. From what I've seen so far, I think bailouts will be more easily avoided. I also think an independent regulator is the way to go. Unfortunately, I think the House's version will be more politically palatable. Banks almost certainly prefer the Fed doing this job, for precisely the reason that it shouldn't: they trust the Fed to ultimately have their backs. Moreover, creating a new agency of this magnitude from scratch might bother some in Washington, even if it is self-funded.