Should the Fed Oversee Systemic Risks?

Published on June 28, 2009

There has been much debate recently regarding the need for a “systemic risk regulator” empowered with the ability to take corrective action to prevent the types of dangerous episodes that have become the norm over the past year.

The Obama Administration seems to be leaning toward empowering the Federal Reserve with a great deal of additional authority, but the notion of expanding the Fed’s power in this manner has attracted bipartisan criticism.  Some critics simply have lost trust in the Fed (or never had much trust in the institution to begin with) while others believe that the Fed must focus on its primary responsibility as currently defined:  price stability and full employment.

Senator Mark Warner (D-VA), has written an op-ed piece in today’s Washington Post where he suggests that a Systemic Risk Council should be established which will have an independent chair but will include as members various regulators including the Chairman of the Federal Reserve.

While setting up additional Federal bureaucracies is not generally something I favor, my view is that the Federal Reserve already has a diluted focus given its statutory responsibility to concern itself with “full employment” in addition to price stability which should be its singular objective.

Here are a couple of excerpts from Sen. Warner’s article:

The events of the past two years have underscored the need for regulation of the financial markets that anticipates and mitigates systemic risk. The events of the past 20 years have demonstrated that the Federal Reserve is the wrong choice as a systemic risk regulator.

First, the Fed has proved itself incapable of managing and preventing systemic risk. Second, sound monetary policy is too important to place at risk with conflicting or diverting responsibilities. Third, the Fed is not structured to provide the transparency and accountability the public deserves. Fourth, this action could concentrate too much economic power in a single institution.

Some have advocated giving more responsibilities to the Fed because it is the only institution sophisticated enough or the only one with the will and motivation to act properly. But those arguments are demonstrably wrong.

What we need is an all-inclusive Systemic Risk Council with an independent chair appointed by the president and confirmed by Congress, and a membership including the Treasury secretary, the chairman of the Federal Reserve and other prudential regulators. A council with an independent staff, the ability to gather any financial information it needs to spot systemic risk, and prophylactic and emergency powers to deal with such risks would be much more likely to stop the next crisis.

The council would focus on one job: systemic risk. By its nature, it could see across the full horizon of banking, securities, insurance and private equity and better anticipate the risks that emerge in an innovative financial sector. Prudential regulators would remain empowered and responsible for systemic risks arising in their jurisdictions. If threats extend beyond the authority of one regulator, the council would ensure comprehensive, coordinated action.

Should the Fed Oversee Systemic Risks?