Federal Reserve Chairman Ben Bernanke is recommending an across-the-board revamp of U.S. financial regulations in an effort to even out the explosive up and down cycles in our financial markets.
“We should review regulatory policies and accounting rules to ensure that they do not induce excessive swings in the financial system and economy,” the central bank chief said today in remarks prepared for an address to the Council on Foreign Relations in Washington.
Bernanke recommended that lawmakers and supervisors rethink everything from the amounts firms set aside against potential trading losses and deposit-insurance fees to protections for money-market funds. His remarks reflect a judgment that the U.S. — like emerging-market nations in the past — failed to properly manage a flood of capital over the past decade and a half.
Bernanke also repeated his call for an agency will keep an eye on and be responsible for financial stability. While he didn’t specify which regulator should take that job, he noted that the Federal Reserve was first formed to address banking panics and said the initiative would “require” some role for the central bank.
Analysts are skeptical that the Federal Reserve will be the singular establishment to emerge with more managerial authority since Congress has been critical of their regulatory oversight as our economic crisis grew.
Bernanke also repeated that the central bank, U.S. Treasury and other regulators “will take any necessary and appropriate steps” to ensure banks have capital to “function well in even a more severe economic downturn.”
Referring to the stress test regulators will use to determine whether banks need more capital, Bernanke said an adverse scenario “involves unemployment averaging over 10 percent for a period, which we view as certainly well within the realm of possibility.”
Among the biggest challenges faced by regulators is addressing the issue of banks that are so big that their failure would put the entire banking system at risk. He said that firms that are too big to fail are “an enormous problem” and that large firms will require “especially close” oversight in the future. Regulators need the authority to seize such firms, such as the Federal Deposit Insurance Corp. already has for deposit-taking institutions, he said.
Bernanke also urged steps to protect against an outflow of money from money-market mutual funds, and said one market where banks and securities firms finance themselves — known as the tri-party repo market — may need to move to a central clearing system.
“Given how important robust payment and settlement systems are to financial stability, a good case can be made for granting the Fed explicit oversight authority for systemically important payment and settlement systems,” he said.
The Fed chairman also called for a review of accounting and capital guidelines that may cause banks to pull back in downturns.
The chairman also believes that capital regulations should be reviewed to ensure that they are appropriately forward-looking, and that capital is allowed to serve its intended role as a buffer — one built up during good times and drawn down during bad times.
Representative Barney Frank, chairman of the House Financial Services Committee, said last month he plans by April to release a draft of legislation designating the Federal Reserve as the overseer.
Senate Banking Committee Chairman Chris Dodd expressed disbelief that the central bank is up to the task, calling its regulation and consumer protection “abject failures.”
“The question is whether we should be giving you a bigger plate, or whether we should be putting the Fed on a diet,” Dodd told Bernanke at a hearing in February, noting that financial policy should remain the Federal Reserve’s top priority.
“When you keep asking an agency to take on more and more, it becomes less and less likely that agency will succeed at any of it,” said Dodd.
The Federal Reserve already supervises about 900 state banks and is the primary regulator for bank holding companies. The Fed also writes consumer protection rules and has the final word on proposed mergers among bank holding companies.
President Obama has asked his economic team to shape legislative proposals within weeks.
The global financial crisis stemmed in part from a failure by government supervisors to accurately measure risk-taking by financial institutions and the ability of lenders and investors to exploit loopholes in oversight, regulators have said.