Should The Treasury Lead Systemic Risk Regulation?

Yesterday, I wrote about how a compromise forming in the Senate for financial reform may include providing the Treasury with more systemic risk regulatory power than the Federal Reserve. The proposal would place the Treasury Secretary at the head of the table and the Fed Chairman at his right hand. Some are criticizing this compromise, because they think it's crazy to give the Treasury regulatory authority. They have some good arguments, but it's too early to know if the compromise is all bad just yet.

A few prominent bloggers are unhappy about this proposal. Calculated Risk quips:

I can just imagine a council in 2004 and 2005 led by ex-Treasury Secretary John Snow with Alan Greenspan as Vice Chair.

And Felix Salmon raises some strong criticisms. He worries that this could result in systemic risk regulation becoming too politically driven, since the Treasury is a part of the executive branch. Consequently it sways as the political winds change in Washington. That's not the mindset you want for a regulator.

He also worries about Congress' influence:

I suppose it makes sense that a member of Congress would want to have anybody and everybody maximally accountable to Congress. But that doesn't make it a good idea. Regulators are like judges: they work best with a minimum of political interference. We saw that with the regulation of Fannie Mae and Freddie Mac: it got hijacked by Congress to the degree that the nominal regulator was to all intents and purposes powerless to do anything but that which Congress demanded. And the consequences were disastrous.

These are all fair objections. But I think we really need to wait a little longer to see how the final proposal reads before jumping to any conclusions.

As I've said before, I would have preferred to see something like in Dodd's original plan, where an entirely new agency was created specifically to monitor systemic risk. That way, you wouldn't have to worry about its independence or bias resulting from other duties. For that reason, I do not advocate providing the Fed with this power.

If the plan calls for a sort of sub-agency in the Treasury to take on this task with real safeguards in place to ensure independence, then it might not be so bad. The role of the Treasury Secretary could turn out to amount to little more than the designation as chairman on a council of virtual equals. He may sit at a round table, rather than at the head of a rectangular one. Unless his vote has more weight or he has some sort of regulatory veto power, his title might not mean that much.

But if it turns out that the Treasury Secretary has a very hands-on role and large degree of autonomy to control systemic risk regulation, then that's bad. Salmon and others are right to worry about the Treasury's independence if that's the case.

I'm hoping for the former conception, but worry we'll get the latter. Maybe it's the cynic in me, but I don't find it altogether shocking that Congress and the Obama administration would prefer to keep this power to themselves, rather than cede it to a new, more independent body as Dodd's original proposal called for.