Daily Archives: April 29, 2010

“A Fed with broad regulatory authority”: Is it a good idea?

According to James Bullard (President and CEO, Federal Reserve Bank of St. Louis), Sandra Pianalto, (President and CEO, Federal Reserve Bank of Cleveland), and  Richard W. Fisher (President and CEO, Federal Reserve Bank of Dallas) the answer is yes.  Recently, they delivered their speeches at the 19th Annual Hyman P. Minsky Conference on the State of the U.S. and World Economies After the Crisis: Planning a New Financial Structure, held at the Ford Fundation on April 14-16, 2010, NY.
The following statements can be found on the conference’s website:

A Fed with appropriately broad regulatory authority provides the nation with the best chance of avoiding a future crisis…Bottom line: Due to its narrow regulatory authority, the Fed had a severely limited view of the financial landscape as the crisis began.” James Bullard, President and CEO, Federal Reserve Bank of St. Louis emphasis in the original

“the Federal Reserve should continue to supervise banking organizations of all sizes and should take on an expanded role in supervising systemically important financial institutions” Sandra Pianalto, President and CEO, Federal Reserve Bank of Cleveland 2010 see here)

“Current proposals being discussed in Congress would shrink the Fed’s regulatory and supervisory responsibilities…leaving us either with no regulatory oversight or solely with regulatory oversight of LFIs. In my view, these proposals are misguided.” (Richard W. Fisher, President and CEO, Federal Reserve Bank of Dallas 2010:4 see here)

On the other hand, Prof. William K. Black, on his testimony on Lehman Bankruptcy (see here and here), opposed to the view that the Fed did not have the appropriate regulatory authority:

“The Fed’s defense of its disgraceful refusal to protect the public is meritless. It argues that it was not there in its regulatory capacity and that it sent only a few staffers that laced the capacity or the leverage to accomplish any supervisory goals. This is either a deliberate obfuscation or a confession of a core failure. As Senior Vice President and General Counsel of the FHLBSF I was always a regulator – even when I was providing involved in credit-side activities. As a lender, the FHLBSF often learned material information about the institutions we regulated because we engaged in effective underwriting of asset quality. My predecessor famously used the leverage of the FHLBSF as lender of last resort for the largest S&L in America, which was in a liquidity crisis, to force out the fraudulent CEO controlling the institution and to enter into a broad array of steps that greatly reduced the institution’s risk exposure and frauds. At its peak, we had roughly 50 FHLBSF credit personnel resident at the S&L. The fact that the FRBNY, which had far more resources than the FHLBSF, chose to send only a token crew to be on-site at a potential global catastrophe is a demonstration of failure, not a valid excuse for their failure to act to protect the public. The FRBNY has vastly greater leverage than the FHLBSF ever had and in the context of the Lehman crisis it had the leverage to force any change it believed was necessary, including an immediate conversion of Lehman to a bank holding company and a commercial bank.

The Fed has inherent problems even in safety & soundness regulation due to its structure. First, the regional FRBs have boards of directors dominated by the industry. Congress already made the policy decision, in removing all regulatory functions from the FHLBs in the 1989 FIRREA legislation, that this is an unacceptable conflict of interest.

Second, supervision is, at best, a tertiary activity at the Fed and regional banks. Monetary policy gets all the emphasis, the credit windows come second, and economic research and safety & soundness regulation vie for a distant third place. (Consumer regulation is a bastard step child at the Fed and most agencies.)

Third, the Fed is far too close to the systemically dangerous institutions. The SDIs are in an ideal position to exploit opportunities for regulatory “capture.”

Fourth, the Fed is dominated by neo-classical economists that have no theory of, experience with, or interest in the complex financial frauds that are the dominant cause of our recurring, intensifying financial crises. Bernanke appointed an economist, Patrick Parkinson, with no examination or supervision experience to head all Fed examination and supervision.

Fifth, the Fed is addicted to opaqueness and its senior ranks believe the bankers when they claim that the people must never be allowed to learn the truth about asset losses. One of the conflicts of interest that a banking regulator must never succumb to is the temptation to encourage or allow the regulated entity to lie about its financial condition for the purported purpose of preventing a run on the bank. Geithner, unfortunately, embraced that temptation and stated it openly to the Bankruptcy Examiner. It is very easy, psychologically, to believe that you are letting a bank lie to the public for a noble reason – protecting the public. The bankers always tell the regulators that the world will end if the banks tell the truth – but that is a lie. Regulators’ greatest asset is their integrity. I was one of the four FHLBSF regulators that met with the “Keating Five.” To this day, I have no idea what political affiliations, if any, my three colleagues hold. We simply insisted on honest disclosures and we always made a referral to our agency to alert the SEC (and the FBI) to any efforts we found to use accounting to deceive the investors or the regulators.”

Prof. William K. Black, has argued elsewhere that “The Fed refused to exercise that authority despite knowing of the fraud epidemic and potential for crisis”. He pointed out that:
“The Fed’s failures were legion, but five are worthy of particular note.
1. Greenspan believed that the Fed should not regulate v. fraud
2. Bernanke believed that the Fed should rely on self-regulation by “the market”
3. (Former) Federal Reserve Bank of New York President Geithner testified that he had never been a regulator (a true statement, but not one he’s supposed to admit)
4. Bernanke gave the key support to the Chamber of Commerce’s effort to gimmick bank accounting rules to cover up their massive losses — allowing them to report fictional profits and “earn” tens of billions of dollars of bonuses
5. Bernanke recently appointed Dr. Patrick Parkinson as the Fed’s top supervisor. He is an economist that has never examined or supervised. He is known for claiming that credit default swaps (CDS, a.k.a the financial derivatives that destroyed AIG) should be unregulated because fraud was impossible among sophisticated parties.
Each error arises from the intersection of ideology and bad economics.
The Fed’s regulatory failures pose severe risks today. Three of the key failed anti-regulators occupy some of the most important regulatory positions in the world. Each was a serial failure as regulator. Each has failed to take accountability for their failures. Last week, Dr. Bernanke asserted that bad regulation caused the crisis — yet he was one of the most senior bad regulators that failed to respond to the fraud epidemic and prevent the crisis. As Dr. Bernanke’s appointment of Dr. Parkinson as the Fed’s top supervisor demonstrates, the Fed’s senior leadership has failed, despite the Great Recession, to learn from the crisis and abandon their faith in the theories and policies that caused the crisis. Worst of all, the Fed is an imperial anti-regulatory seeking vastly greater regulatory scope at the expense of (modestly) more effective sister regulatory agencies. The Fed’s failed leadership is setting us up for repeated, more severe financial crises.” (see here)