In the category of a stopped clock being right twice a day, the Senate seems to have come up with a compelling piece of bank regulation. I don’t like its chances to get passed, but it would be great for the nation:
WASHINGTON — Senate Democrats circulated a plan Tuesday that would impose sweeping curbs on the Federal Reserve, posing the biggest legislative challenge to the central bank in decades and illustrating how divided Capitol Hill remains about the future of financial regulation.
The move is part of a broader 1,136-page proposal by Senate Banking Committee Chairman Christopher Dodd aimed at rewriting how financial markets are overseen. It would create a single banking regulator, a powerful council of regulators to monitor systemic risks to the economy and a Consumer Financial Protection Agency to write and enforce rules on products such as mortgages and credit cards.
This bill has a number of good ideas, and one excellent principle: the Fed should be independent, even when it doesn’t want to be.
Right now the Fed has the awesome responsibility of defending our currency. It also has the conflicting responsibility to maximize employment, but let’s focus on this currency thing…the need to maintain purchasing power is the reason the Fed cannot be an ordinary government agency (say, a unit of Treasury). Politicians face the overwhelming temptation to goose the economy during the run-up to elections. Someone is always running. Chris Dodd himself is in for a fight in Connecticut in 2010, and would likely be amenable to any sort of deal that could get interest rates reduced (assuming, of course, that there were any room to reduce rates). If the central bank were under executive or legislative control, we would soon have the American peso.
Our attempt to firewall the Fed – dispersed boards, off-cycle appointments, picking economists instead of professional politicians, etc – runs aground when the Fed itself decides not to play along. Sometime in September 2008, when the world was melting down – Lehman broke, Merrill in panic, AIG out of gas, Reserve Fund breaking the buck – and the executive was either plainly incompetent (Dubya) or off chasing grudges (Paulson), Bernanke took it upon himself to form a one-man government of the financial sector.
Ben’s decision to become a sovereign state of his own – Ben President separating the naughty and the nice, Ben Congress supplying the money from the Fed’s balance sheet, Ben Supreme Court telling Ken Lewis that the Material Adverse Change provision of BAC’s purchase agreement with ML was inoperative – showed that the Fed would take advantage of any power it could conceivably grab. And the Fed’s job as regulator keeps the Fed involved in stuff it has no business focusing on. Does anyone think that a Fed that is regularly in contact with Wells Fargo is going to raise rates if Wells is in danger, regardless of how important it might be for the country?
Defending the dollar is hard work. It’s a full-time job, and Bernanke should have all of his time to do it.
That’s not all the good stuff in Dodd’s bill. It resurrects the CFPA and introduces government appointment of the directors of the regional Fed banks. But refocusing the Federal Reserve is reason enough to pick it over the competing proposals in DC. The irony is that it may also be the bill that gives the Fed the most promising future. Without some manner of reform, the pressure from Congress to audit the Fed will grow until it cannot be resisted, and while I support the audit in principle, the likely politics of the thing is that as soon as the audit is done Congress will want a say in what the Fed is doing. Far better to get down to size today and defend the far more reasonable position that monetary policy must be isolated.