New Compromise Forming For Systemic Risk Regulation

Lawmakers might be on the brink of finally deciding how a new systemic risk regulator should be structured. The New York Times reports that a new compromise would create a council of regulators, led by the Treasury Secretary. It would also reduce the amount of new power given to the Federal Reserve and provide more to the new council and Treasury. This is a good development: it demonstrates a move towards a better solution for systemic risk regulation and shows continued progress in the financial reform effort in the Senate.

First, is this compromise more like the Senate's proposal or the legislation the House passed in December? Recall, the Senate sought to create a new agency to handle systemic risk, while the House wanted to give most of the regulatory power to the Fed. Unfortunately, this report provides few details. In addition to explaining that there would be a council of regulators headed by the Treasury Secretary, it says:

Assigning the Treasury Department the job of spotting incipient trouble and addressing it quickly has support among senators from both parties, though several important provisions, including whether the council would have the ability to bypass existing banking regulators and impose its own rules on huge financial firms, remain to be worked out.

The effect would be to diminish the authority of the Federal Reserve, whose regulation of banks has been criticized for failing to head off the problems.

From this, it sounds like a true compromise. In the House version, the Treasury Secretary led a council of regulators who looked at big picture issues. That appears to remain intact. The original Senate version would have had its new systemic risk agency chief as leader of the council. But if the Times' source is right about the diminished role of the Fed, then that's a win for the Senate's vision. It sought to have a separate regulator take on this duty. While it appears that no entirely new agency would be created by the compromise, more power would lie within the Treasury and council, not the Fed.

This makes a lot of sense. Here's why:

"Let the other traditional regulators focus on direct banking regulation and have the Fed focus more exclusively on monetary policy," said one committee member, Senator David Vitter, Republican of Louisiana. "It's not like they have a small or unimportant portfolio."

The idea is that the central bank should stick to central banking. When it comes to systemic risk, it would still have an important seat at the table, as the Fed chief would be vice chairman of the council. So it would still share any data that it has compiled on mounting systemic risk. But the actual regulatory authority would be elsewhere, as it should be. That eliminates any conflict of interest that could exist between prudent regulation and central banking. It would also allow the Fed to focus on its already challenging purpose.

One sort of obvious takeaway from this news is that the Senate's effort is hardly stalled. The Times reports that Senate Banking Committee Chairman Christopher Dodd (D-CT) and at least a few prominent Republicans, including Richard Shelby (R-AL) and Bob Corker (R-TN), also think it makes sense for the Fed to have less power in systemic risk regulation.

The Treasury, and consequently the White House, is also on board. That, however, should be unsurprising, since the executive branch is the big winner in the compromise, as it would gain most of the power the Fed loses. Yet, according to this report, even Fed Chairman Ben Bernanke is okay with this new proposal. The article is unclear on how the House will react. While that's important, the House based most of its bill on the Treasury's original proposal. So if it's taking orders from the White House, then it should also comply with these changes.

I'll continue to closely monitor how this compromise evolves. We still don't know many of the details, so I'm not entirely convinced that the final bill will look like what this report indicates. The Fed may still end up with more power, particularly if the House balks. But overall, this news is very encouraging.