December 11, 2009 / 9:56 PM / 9 years ago

SCENARIOS-U.S. financial reforms could shrink Fed's role

WASHINGTON, Dec 11 (Reuters) - The U.S. House of Representatives on Friday approved a financial reform bill that would expose the Federal Reserve to more scrutiny, threatening its cherished political independence.

The provision is one of several in the House legislation that would affect the central bank. The Senate is also mulling proposals that could alter the Fed’s role, with one leading plan aiming to strip the central bank of its bank regulatory powers.

What emerges at the end of the legislative process will need to be a compromise hammered out between the House and Senate bills.

Following are brief descriptions of the various proposals affecting the Fed, and a look at possible scenarios as the legislative process unfolds:

HOUSE PROPOSAL

* The House bill contains systemic risk regulation provisions that would allow the Fed to limit credit exposures at financial firms, block acquisitions, restrict pay and shut down undercapitalized firms.

* Bill makes Fed part of an inter-agency Financial Services Oversight Council chaired by Treasury secretary.

* Bill would strip Fed of its consumer protection job and give it to new agency.

* Measure would allow audits of monetary policy and the Fed’s lending to financial firms. Monetary policy audits could not become public until six months after any Fed decision.

* Bill would put new limits on Fed’s “lender of last resort power” by restricting its so-called 13-3 authority to lend money to firms other than banks in “unusual and exigent circumstances.”

* Bill would cap Fed emergency lending at $4 trillion.

SENATE PROPOSAL

* Senate Banking Committee Chairman Christopher Dodd has proposed a bill to create a systemic risk regulation agency with an inter-agency board.

* Senate bill would strip Fed of consumer protection duties and relocate them in new agency, like House bill.

* Bill would also strip Fed of bank supervision duties and centralize them in new super-regulator for the banking industry, a dramatic step the House bill lacks.

* Bill would give power to name members of the boards of the 12 regional Fed banks to Washington, taking it away from banks in those regions. President would appoint regional Fed board chairmen, subject to Senate confirmation.

* Like House bill, Fed’s 13-3 authority would be limited.

* Senate bill would permit audits of Fed emergency lending facilities, allowing for disclosure of borrowers after one year, but does not authorize audits of monetary policy.

* A separate bill mirroring Paul’s measure in the House has been introduced in the Senate and has gained 30 co-sponsors.

SENATE SCENARIOS

* Debate in the Senate Banking Committee is expected to extend well into 2010.

* Senate Republicans disagree with Dodd on key parts of his proposal.

* Approaching November 2010 mid-term elections may frustrate efforts to pass far-reaching financial reform legislation.

* Fed expected to lobby to block audit provision. May cede consumer protection authority but likely to fight to retain bank supervision authority.

* If Senate Banking Committee approves reforms such as Dodd’s, Fed would be relegated largely to managing monetary policy.

* Any bill approved in Senate would have to be reconciled with the House bill, then signed into law by the president.

MARKET OUTLOOK

* Financial markets could be unsettled if a measure opening interest rate decisions to audits looks likely to survive.

* Investors could view Fed as under political pressure to keep growth humming, especially as elections approach. Inflation expectations and longer-term interest rates could rise. Fed officials have said economy could be harmed.

* Fed, knowing Congress is looking over its shoulder, could become more cautious and choose options that conform to established models, rather than using unconventional tactics.

* Or the audit provisions, if enacted, could draw only a yawn from markets. Investors may assume monetary policy remains insulated from politics because of the six-month delay in making deliberations public. Fed officials could find their decisions are easy to justify to lawmakers whose constituents favor a tight grip on inflation and price stability.

* Markets could also view the Fed as weakened if Congress strips it of bank supervision duties. Britain is eyeing a bigger regulatory role for the Bank of England, which had focused solely on monetary policy, after the financial crisis exposed weaknesses in the oversight structure. Fed officials have argued their supervisory duties inform their rate decisions.

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