Tag: banking regulation

Midterm Impact on Financial Regulation

With Republicans taking the majority (but far short of control at 60) in the Senate and increasing their majority in the House, the regulation of our financial markets may see renewed attention, with particular focus on reforming Dodd-Frank. My former employer Senator Richard Shelby takes the Chair on the Senate Banking Committee, while Congressman Jeb Hensarling retains his leadership role on House Financial Services.

In my nearly twenty years following financial services, we have not had two chairmen more skeptical of government oversight of our financial markets. While neither could be called “libertarian,” both are suspicious of big government as well as big finance.  Both agree that “Too Big To Fail” is a real issue and one created by the actions of government, not the market.

Sen. Shelby, for instance, has repeatedly said “no one is too big to fail” - what he means here is that no company should be getting a bailout.  It was for that reason he led the charge in the Senate against the TARP, and also for that reason he voted against the Chrysler Bailout in 1979.  Shelby also led the efforts to reform Fannie Mae and Freddie Mac, warning years before their failure of the various flaws inherent in a mortgage model of privatized gains and socialized losses.  Shelby also tried to bring more competition to the credit rating agencies, passing legislation in 2006 to reduce barriers to entry in that market.

The above, however, should not be read to overstate the case.  Both Rep. Hensarling (who apparently had a subscription to the Cato Journal in college) and Sen. Shelby would like to see the federal safety net behind our financial markets reduced, allowing a greater role for market discipline.  Perhaps even more rare in D.C., they both believe their chairmanships come not just with privilege but great responsibility.  If it were simply up to these two to agree, I have confidence that our system of financial regulation would be greatly improved, reducing bailouts and increasing stability.  

But it isn’t up to these two. There are numerous protectors of the status quo in both major political parties.  Both would also have to reach agreement with the Obama Administration, which seems quite comfortable with bailouts and regulatory discretion.  Ultimately, the many obstacles our Founding Fathers wisely put in place for legislation will prove too high for Shelby and Hensarling to implement all but modest reform.  

But at least financial regulation is unlikely to get any worse.

Dimon on NY Fed Board a Distraction, Solution Is to Remove the Fed from Bank Regulation

It is not surprising that the recent losses at JP Morgan have resulted in calls by current and would-be politicians to remove bankers from the boards of the regional Federal Reserve banks, as JP Morgan CEO Jamie Dimon currently sits on the board of the New York Federal Reserve. There’s even a petition for the “public” to demand Dimon’s resignation. Setting aside the irony of having senators call for keeping bankers off the regional Fed boards just days after they voted to place a former investment banker on the Federal Reserve board, the real question we should be debating is: Should the the Federal Reserve even be involved in banking regulation?

As I’ve noted elsewhere, a recent paper by economists Barry Eichengreen and Nergiz Dincer suggests that separating monetary policy from banking supervision would yield superior outcomes, both for banking stability and the economy more generally. While there is a very real conflict-of-interest when bankers sit on the boards of their regulators, there is an even bigger conflict-of-interest when those setting monetary policy are also responsible for bank safety. Rather than let institutions they supervise fail, and face public criticism, there exists a strong incentive for the monetary authority to mask bank insolvency by labeling such a liquidity crisis and then injecting easy and cheap credit. The result is that the rest of us are left paying for the mistakes of both the bank and regulator. A far better alignment of incentives would be to separate the conduct of monetary policy from bank supervision.

Like anything, such a separation would not be without its costs. I am the last to go around claiming a “free lunch” when it comes to banking and monetary policy. The current Boston Fed President made a strong case over a decade ago for keeping the two combined. The Richmond Fed has also offered a useful discussion of the pros and cons of such consolidation, as well as consolidating regulators more generally. These costs aside, I believe having the Fed focus solely on monetary policy would improve both.