A new role as 'risk regulator' could reshape Fed

Tuesday, June 16, 2009

WASHINGTON -- The Obama administration's plan to revamp regulation and prevent any more crashes like those that felled AIG and Lehman Brothers includes a bold new idea: Empower the Federal Reserve to oversee the biggest financial players whose failure could threaten other institutions and the economy.

But some lawmakers and economists say making the Fed a "systemic risk regulator" would itself be a high-stakes risk that would distract from its core mission: reviving the economy.

They say the Fed shares blame for the financial crisis that erupted last fall. Along with other regulators, it failed to crack down on risky mortgages and lax lending standards that ignited the crisis.

Unless the Fed improved its oversight abilities, "giving the Fed more responsibility at this point is like a parent giving his son a bigger and faster car right after he crashed the family station wagon," said Mark Williams, professor of finance and economics at Boston University and a former Fed bank examiner.

Treasury Secretary Timothy Geithner and Lawrence Summers, head of the White House's National Economic Council, said in an opinion piece published Monday in the Washington Post that the Fed would become a "systemic risk regulator" for "large, interconnected firms whose failure could threaten the stability of the system."

They also would create a council of regulators, Geithner and Summers wrote. These regulators -- which weren't identified -- would serve as extra eyes and ears to help the Fed oversee financial products.

President Barack Obama plans to unveil the regulatory plan Wednesday, with congressional hearings the next day.

Even inside the Fed, there's recognition that its examiners would need to improve their ability to detect risks if it was to be made a new financial supercop. Under Alan Greenspan, who led it for 18 years, the Fed and other agencies overlooked the risks of allowing exotic mortgages to go to financially shaky borrowers. And they resisted efforts to regulate risky and complex instruments such as derivatives.

"We must ensure that we continue to increase our expertise so it is properly matched with the problems and challenges we will face in both our bank supervisory role and in meeting our traditional financial stability mandate," Chairman Ben Bernanke acknowledged in a recent speech.

Some lawmakers and Wall Street analysts worry, too.

Senate Banking Committee Chairman Christopher Dodd, D-Conn., and Sen. Richard Shelby of Alabama, the committee's senior Republican, say they're concerned about overloading the Fed while it's managing the financial crisis and fighting the recession. They say it needs to focus on monetary policy -- the decisions about key interest rates that affect the economy.

Expanding the powers of the Fed, whose members aren't elected, would also raise concerns about accountability. Though the Fed has sought to be more open, it remains one of Washington's most secretive institutions.

"I just think we're heaping too much on the Federal Reserve," said Rep. Paul Kanjorski, D-Pa., a member of the House Financial Services Committee. Kanjorski said it would be a mistake to further empower an agency not accountable to Congress or the president.

"You can't fire the chairman of the Federal Reserve," said Kanjorski, who thinks the role of risk regulator should be given to the Treasury Department.

Michael Feroli, an economist at JPMorgan Economics, agreed: "The more the Fed leadership has to deal with, the less time it has to focus on any single issue."

The Fed had no official comment on the administration's proposals as laid out Monday by Geithner and Summers.

Many analysts agree that a potent regulator is needed to make sure institutions don't take the kinds of risks that last year ended up imperiling the banking system. When American International Group stood on the brink of collapse last year, for example, the Fed had to rescue it for fear AIG's failure would devastate the economy.

AIG's undoing was an unregulated unit that made disastrous bets on mortgage-backed securities and mismanaged credit default swaps -- a form of insurance against bond defaults. With a systemwide risk regulator, the idea is that such problems could be spotted beforehand. Safety nets -- like stiff capital requirements to protect against future losses -- would be imposed.

It's unclear whether the Fed would have to hire additional banking examiners or other specialists to carry out its supercop duties. And it's not known how much other agencies would share information about companies or products.

Partly out of fear of concentrating too much policing power in the Fed, a council of regulators would work with the Fed to supervise "too-big-to-fail companies." Sheila Bair, head of the Federal Deposit Insurance Corp., and Mary Schapiro, chair of the Securities and Exchange Commission, favor this idea.

Even if the Fed's powers were expanded, history suggests it might be impossible to spot the next financial bubble -- whether in housing, the stock market or elsewhere -- before it forms.

"A strong systemic risk regulator is important," said Terry Connelly, dean of Golden Gate University's Ageno School of Business in San Francisco. "But you probably won't catch everything."


AP Writers Jim Kuhnhenn and Anne Flaherty contributed to this report.

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