Shooting from the hip when you’re trying to reform the regulation of banks is not good. What I have seen in Democratic Sen. Christopher Dodd’s bill worries me — a lot.
The Federal Reserve is built on a decentralized structure that encourages businesses, banks and the public to participate and to cooperate in getting things done. It is nearly impossible for any single group — including Congress — to dominate decision-making.
Dodd’s misguided bill threatens that structure under the guise of removing conflicts of interest. In fact, it would only reduce the professionalism of the Fed and increase the political role of Congress in monetary policy.
The choice of Federal Reserve regional bank presidents is at the core of the Fed’s populism — and its success. The selection process balances the interests of business, the public and banks, while also giving voice to the small, medium and large entities within each group.
No Federal Reserve bank ever “appoints” a president. A candidate becomes a president only after having been nominated by the regional Federal Reserve bank’s directors and approved by the Fed’s Board of Governors. This veto power in Washington ensures that only well-qualified persons are nominated and eventually accepted.
Dodd’s proposed Senate confirmation power over appointment of Fed regional bank presidents would be a misdirected reform. Even worse would be Democratic Rep. Gary Peters’ proposal to take away the vote of Federal Reserve regional bank presidents on the Open Market Committee.
Dodd’s bill would change the current approach into a Washington-centric one laced with opportunities for political meddling. His bill would increase the power of the Federal Reserve Board at the expense of the system’s regional banks. The bill also would create a centralized regulatory agency vulnerable to regulatory capture by the powerful, as happened to the now defunct Interstate Commerce Commission.
Poorly conceived attempts to fix the Fed’s problems risk losing its best features.
One great asset is the Fed’s intellectual capital. Many Fed economists are thought leaders in their fields, both publishing in and serving as associate editors of professional journals.
Since I left the Federal Reserve Board staff 28 years ago, I have been impressed by the growing competence of the regional banks in influencing monetary policy. The economics profession’s respect for the research staffs and presidents at those regional banks has steadily grown. Nine of the 12 presidents are Ph.D. economists. The only other central bank in the world having comparable research and policy competence is the European Central Bank in Frankfurt, Germany.
Yet some regulatory changes need to be made. The 1980 Monetary Control Act granted all banks, along with other depository financial institutions, the right to offer checkable deposits, settle payments at the Federal Reserve and borrow from the Fed’s discount window — but it did not require them to become members of the Federal Reserve System.
It is time that all banks were required to be Fed members. That would eliminate “regulatory shopping,” by which banks seek the most permissive regulator among state regulators, the FDIC, the comptroller’s office and the Fed. Such behavior produces an incentive for regulators to adopt lax regulatory policies. It is time Congress ended it.
I am also concerned about the 1956 Bank Holding Company Act and its Gramm-Leach-Bliley revision. Under this act, the Federal Reserve regulates all large financial holding companies, including most large commercial banks and the surviving former investment banks. The problems of troubled Citicorp do not speak well of the existing approach. But that regulatory authority is centralized to the Federal Reserve Board staff’s Supervision and Regulation Division in Washington, so it cannot be blamed on the regional banks.
Involving the decentralized Federal Reserve banks in that supervision might be a positive change by reducing opportunities for political meddling.
The votes of the regional bank presidents on the Federal Open Market Committee have often been a source of constraint on what otherwise could have been less desirable monetary policy. An example is the outspoken Thomas Hoenig, president of the Kansas City Fed.
Finally, I see little in Dodd’s bill that would address the problems of inadequate policy transparency, the sometimes shockingly low Federal Reserve data quality and the anti-competitive concept of “too big to fail.”
Regarding Fed policy, Congress has been asleep for 25 years. Now that it is waking up, I am worried that the sleeping giant may stomp in the wrong places.
William A. Barnett is the Oswald Distinguished Professor of Macroeconomics at the University of Kansas and was on the staff of the Federal Reserve Board from 1973 to 1981. He is editor of the Cambridge University Press journal, Macroeconomic Dynamics.
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