June 25 A landmark financial overhaul bill hammered out by congressional negotiators would alter the role of the Federal Reserve by giving it greater responsibility to police the broad financial system as part of an interagency Financial Stability Oversight Council.
The Fed would also have a mandate to supervise risky non-bank financial firms regarded as critical to the system.
The U.S. central bank will be subject to greater oversight from Congress, but it has largely avoided changes Fed officials warned would erode its independence from political pressure.
Following are views from prominent economists on how regulatory reform will change the Fed:
ANIL KASHYAP, PROFESSOR, UNIVERSITY OF CHICAGO'S BOOTH SCHOOL OF BUSINESS
"The success of the systemic regulation plan ... depends on an unrealistic amount of cooperation across the new Council, the Fed, the new office of financial research in the Treasury and the other primary regulators. I do not expect it to work well and there is a risk the Fed will wind up being blamed for a group failure. I also worry that there are not enough tools to adequately monitor and regulate the so-called 'shadow banking system.' Rules are going to be tightened for the banks and this will push more activity into the shadow banking system, making the lack of tools for regulating it a potentially big problem."
MAURICE OBSTFELD, PROFESSOR, UNIVERSITY OF CALIFORNIA AT BERKELEY
"The Fed's new macroprudential remit will codify a broader view of the threats to economic stability than has often been taken in the past. This healthy and necessary development is not without cost. The Fed will have to articulate concerns that may be more difficult to explain than a simpler calculus involving near-term inflation and unemployment alone. Such apparent ambiguities could open the door to stronger political pressures."
RICARDO CABALLERO, PROFESSOR, MASSACHUSETTS INSTITUTE OF TECHNOLOGY
"The Fed is the right institution to monitor macroeconomic risks in the financial system as a whole, and it should remain independent from political pressure. Regardless of any new explicit mandate, central banks around the world are fully aware that they need to pay much more attention to the systemic risks buried in the complexity of the financial network and innovation. Moreover, they also know that regardless of regulatory efforts, crisis will repeat in the future and hence it is important that they design new tools to support a financial system once panic sets in. The conventional lender of last resort facility is clearly insufficient in the modern financial system."
ALAN BLINDER, PROFESSOR, PRINCETON UNIVERSITY AND FORMER FED VICE CHAIRMAN
"The bill will clearly strengthen the Fed and add substantially to its responsibilities. Its monetary policy independence is no longer threatened ... thank goodness. The Fed gets additional supervisory authority where bank holding companies and systemically important non-banks are concerned. It also will be given new responsibilities for monitoring systemic risk -- as it should. This last will, I hope, lead to the creation of a whole new division within the Fed staff in Washington. In addition, the bill will require a tremendous amount of work by the Fed's lawyers, and those at the other regulatory agencies, to write specific regulations implementing the new laws."
MARK GERTLER, PROFESSOR, NEW YORK UNIVERSITY
"Much to my surprise, it looks like Congress may be getting things largely right. Giving the Fed central authority over financial stability is vital for the long term health of the economy. The Fed is the only institution capable of responding quickly to a financial crisis. As such, it is critical that it is able to monitor and supervise financial markets and institutions. Limiting the Fed's role in this game would be much like limiting the fire department's role in preventing and fighting fires. I see the Fed's role in financial stability as a natural evolution. Since the 1980s, financial instability has increased in importance as a source of economic instability across the globe, and central banks have been responding in kind."
GLENN HUBBARD, PROFESSOR, COLUMBIA UNIVERSITY AND FORMER ADVISER TO PRESIDENT GEORGE W. BUSH
"The Fed will need to beef up its ability to investigate sources of systemic risk -- something it should already be doing, but its very sanguine attitude at the onset of the financial crisis suggests a need for improvement. To do its job, it will also need to collect data from large non-bank institutions, including very large hedge funds and insurers. The danger is that the Fed has wandered into distinctly political areas with the new authority. Indeed, the Fed's expansion of authority in the recent crisis already potentially compromised the independence of monetary policy."
ALLAN MELTZER, PROFESSOR, CARNEGIE MELLON UNIVERSITY'S TEPPER SCHOOL OF BUSINESS
"Congress missed an opportunity to improve monetary and financial regulatory policies. The Federal Reserve began life under the gold standard. That restricted their action. We badly need new restrictions that limit their monetary actions and give them incentives to look over a longer term. Also ... we need to ... end bailouts. Putting the secretary of the Treasury in charge of decisions to prevent bank failures is a major mistake."
RANDALL KROSZNER, PROFESSOR, UNIVERSITY OF CHICAGO'S BOOTH SCHOOL OF BUSINESS AND FORMER FED GOVERNOR
"Drawing and monitoring the border between systemically important and other institutions and markets will be one of the greatest challenges the Fed will face. There will be strong incentives for risky activities to migrate into the shadows just beyond the border where they can pose serious dangers through interconnections to the entire system. There is also the potential for strong political push-back as supervisors try to move into new areas to slow their growth."
MARVIN GOODFRIEND, PROFESSOR OF ECONOMICS, CARNEGIE MELLON UNIVERSITY'S TEPPER SCHOOL OF BUSINESS
"Fed monetary policy must be operationally independent of the fiscal authorities to anchor inflation expectations and maintain price stability. Credible Fed independence requires the support of Congress in two ways. Congress must accept the priority for low long-run inflation. Congress also must clarify the boundary of the Fed's independent credit policy responsibilities so the Fed does not to invade the territory of the fiscal authorities and jeopardize its independence. The independent Fed cannot be the front line of fiscal policy support for the financial system in times of stress. Regulatory reform does little to address these potential ambiguities, and so has not done enough to secure the foundation of credible, independent central banking in the United States." (Reporting by Mark Felsenthal; Editing by Kenneth Barry)