Who Will Be King Regulator?

The financial regulation news of the moment is that Congress and the administration have reached a consensus for the Treasury to take the lead on a new council designed to regulate systemic risk. Remember, one problem of 2008 was that no one was tasked with looking out for threats like AIG that endangered the broader financial system. Reformers want to fix this problem by making sure a council keeps an eye on the big picture. Like Felix Salmon, I think this is not the best idea.

To begin with, we should probably recognize that the Treasury plays more of a role in the current regulation system than we typically acknowledge; both past Treasury Secretary Hank Paulson and now Tim Geithner are very involved in regulatory decisions and work closely with supposedly independent agency heads. But formalizing and increasing this role is a problem for precisely the reason that Congress likes it: Regulators will be more accountable to the political process. But the political process is already all-too-accountable to the financial sector, and this new arrangement would put even more banking industry pressure on regulators.

In general, I've been pretty convinced that the Fed is the right institution to take the lead on systemic risk, as Tyler Cowen argues here. Of course, other Fed reforms -- especially removing the involvement of banks in regional Fed governance, giving consumer financial protection duties to an independent agency, and appointing governors who take full employment as seriously as inflation -- are a necessary part of this package.

Another viable option to lead the regulatory council would be the newly consolidated regulatory authority for national banks that Dodd is seeking to create. But Treasury will raise too many problems of political conflict of interest, regulatory capture and general chaos -- imagine the Treasury Department trying to regulate for the last year with none of the top political appointees in place.

-- Tim Fernholz

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