The Federal Reserve is going through a historic time on several levels. First, there were the unprecedented actions that it took to save the financial markets in 2008. Now, it has the difficult job of unwinding all that this year. As if that's not enough, it has to contend with sweeping new financial regulation being drawn up by Congress, which may either limit or expand its power. Throw in some significant changes to its leadership team and you've got an incredibly difficult and tumultuous time for the Fed.

Success Breeds Skepticism

There's a broad spectrum of opinion on how the Fed did during the crisis. Some believe that the Fed saved the day. Others think the Fed went too far and should not have acted as aggressively. I believe those in the latter group are misguided: if any party should be credited with rescuing the U.S. economy from drifting into the abyss, it was the Fed.

Of course, its job is not over. Winding down all that action puts it in uncharted territory. Its balance sheet is enormous, and it has to figure out a way to slowly tighten credit so not to disturb the recovery and create a double dip recession. But that's a challenge that lies ahead, not a reflection of its success over the past two years in stabilizing the U.S. markets.

Yet, Americans deeply disapprove of the Fed. This summer, a Gallup poll indicated that that the Federal Reserve Board's approval was at just 30% -- lower than the IRS! And for what? Saving the economy? The truth is that people don't like what they don't understand, and when it comes to transparency and simplicity, the Fed doesn't get very high marks.

Financial Regulation's Effect

Financial reform efforts in Congress hope to address some of that. The House bill includes some changes to enhance transparency of the Fed. But there's little Congress can really do for simplicity: the Fed, by its very nature, handles very complex financial matters. Average Americans aren't likely to fully grasp all it does, but the hope would be that better transparency could alleviate some of their fears.

Of course, financial regulation also has an awful lot to say about what the Fed's role will be going forward in the financial markets. The House's bill would provide the Fed with a great deal more power. It would have most systemic risk regulatory authority. The Fed chairman would also lead the systemic risk council.

But the Senate's version may take a very different route. According to news out today, the bipartisan measure being drafted by the Banking Committee may actually strip the Fed of most of its bank supervising. We've already learned that Senate might also want to limit the Fed's role in systemic risk regulation, as the treasury secretary may lead the council with the executive branch obtaining most of the power instead. The Fed may, however, be provided consumer protection responsibility.

The Power That Must Remain

Interestingly, the Obama administration supports the House's conception of financial reform: it doesn't want power taken from the Fed, but actually wants the Fed to be granted more systemic regulation authority. In yesterday's Treasury blogger briefing, it was clear that senior officials worry about legislation which would strip the Fed of its emergency stabilization powers. But I wonder whether the Senate's plan really does that.

We don't know all of the details yet of what the Senate will propose, but it is possible to consolidate banking regulation, stripping it from the Fed, while allowing the central bank to maintain its emergency stabilization authority. The trick, I think, would be ensuring that the new bank regulator had very direct communication with the Fed and provided it with timely information regarding the health of banking. But if the Fed is also deprived of its power to put out fires, then that would be bad. It has the ability to act more quickly and decisively to stabilize markets than any other government entity.

Leadership's New Face

Finally, there's the additional complication of some faces changing at the Fed in the months to come. It's set to get a new vice chairman with the current veteran Donald Kohn retiring. That and a few other openings will provide the Obama administration the opportunity to give the Fed a makeover. Given the administration's political objectives, I think it's unlikely we'll see any Wall Street bankers strongly considered. Instead, I'd expect nominees to have strong academic credentials and some experience with regulation. Of course, the administration could wait to see how the powers of the Fed are changing to decide what types of economists would best fit its new duties.

The Fed has become surprisingly controversial over the past few years. It used to be a quiet government entity, only paid attention to by bankers. But the financial crisis thrust it into the spotlight: Chairman Bernanke was even named "Person of the Year" by Time Magazine. The most radical edges of either party have unexpectedly found some common ground through their dislike of the Fed. Conservatives, led by Ron Paul, think it has too much power and not enough supervision. Some progressives worry that the central bank has never truly been independent, since it has a lobbyist. Both ends of the spectrum want the Fed's responsibility limited, not increased. The way the Senate's bill appears to be shaping up, it's a battle they may win.

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