Sen. Chris Dodd (D., Conn.) has overseen the compilation of another dictionary-sized piece of impenetrable legislation, this one intended to reform our bank regulators and thereby prevent a repeat of the recent financial crises. His approach is the wrong one, undermining the institutions that have performed relatively well, such as the FDIC, politicizing the Federal Reserve, and creating a raft of new regulators with disconsonant mandates. It does little to address the problems that led up to the credit crunch and much to ensure that future disturbances are handled less adroitly.
Of all the federal regulators, the Federal Deposit Insurance Corporation has performed most capably during the subprime fiasco. It has performed as well as it has because it has a fairly narrow, well-defined mandate — insuring Americans’ bank deposits — and because banks backed by the FDIC are obliged to play by its rules. It makes sense that the insurer of depository institutions is also their regulator: Because the FDIC is on the hook for bank deposits, it has a good financial incentive to manage banks’ risks intelligently. Under the Dodd proposal, the FDIC would still be on the hook, but its regulatory authority would be transferred to a new regulator, which would not have the same powerful financial incentive. In short, the FDIC would still be liable for covering the bets, but the rules of the game would be written by someone else. It is notable that, throughout the course of this extraordinary period, no American’s access to his bank deposits has been disrupted: FDIC resolutions have been smoothly and speedily executed. Everybody’s ATM card kept working, and our certificates of deposit were in good hands. We defy Senator Dodd to name one other federal agency with as good a record.
Senator Dodd’s legislation would also give Congress a much stronger voice in naming board directors at the Fed’s regional banks and would require Senate approval of their chairmen. It would transfer the Fed’s responsibility for maintaining an even economic keel to a new Agency for Financial Stability — as though creating a new bureaucracy with “financial stability” in its name were the same as creating financial stability itself. It is important that the Fed, in its function as arbiter of interest rates, remain independent from political interference. Imagine if Fed chairman Paul Volcker, whose extraordinary and extraordinarily painful actions ultimately tamed the runaway inflation of the Carter years, had been obliged to do that work through an agency politically answerable to Tip O’Neill’s congressional Democrats. TARP was expensive, but 13.5 percent inflation (Mr. Volcker wrestled it down to 3.2 percent) is much more expensive. The Fed’s independence should be considered sacrosanct.
The FDIC’s main failing was its decision to stop collecting insurance premiums from the banks it backstops for a decade. Had it collected them, it would have had a much more comfortable capital cushion during this crisis. The Fed’s failings were more complex: ignoring the asset-price bubble in housing because rising home prices make homeowners happy, missing the fact that securitization had served to concentrate risk rather than to disperse it, and suffering from a consequent inability to foresee the deep and interlocking dangers presented to the world financial system by the housing bubble. (And it bears keeping in mind that the housing bubble itself was in no small part the outcome of longstanding government policies.) Senator Dodd’s response is to create three additional agencies in the hope that they will evolve into creatures more fit than their bureaucratic ancestors — but there is no good reason to believe that they will.
Of the new agencies Senator Dodd proposes to create, there is the aforementioned Agency for Financial Stability, a Financial Institutions Regulatory Administration (a single giant regulator for banks, insurance companies, and the like), and a Consumer Financial Protection Agency that would be charged, among other things, with enforcing the Community Reinvestment Act (CRA). Each of these comes loaded with problems: Having the Fed conduct monetary policy while its financial-stability portfolio is transferred to a new agency makes no sense; it is not clear that one agency could intelligently do one of those jobs without in effect doing the other. The single financial-institutions regulator would bring very different kinds of enterprises under the administration of a single agency, an arrangement that has no obvious benefit and would concentrate the risk of gross misregulation. And as for the consumer-protection agency, it is clear that the CRA is one of the factors that created this mess, and that it should be repealed rather than entrusted to a new regulator that will enforce it even more vigorously.
We do not often find ourselves writing this, but we prefer the approach put forward by Rep. Barney Frank (D., Mass.) and endorsed by FDIC chairman Sheila Bair. Their proposal would give the Fed stronger bank-oversight powers and would create an FDIC-style fund that would be used to resolve “too big to fail” institutions when necessary. The proposal has its shortcomings, but an approach rooted in what works — and the FDIC works — is preferable to rootless regulatory innovation driven by political demands. The Frank-Bair approach would have the added benefit of setting aside rainy-day money before the storm clouds are upon Wall Street, and it appropriately would impose a cost on financial institutions that today receive a subsidy in the form of the implicit and explicit support of the American government. Dodd can mint new regulators just as fast as the government mints money, but neither one will buy us out of this mess.