The Fed in Charge of Systemic Risk? What a Mess

The big winner of the Obama financial-regulation plan appears to be the Federal Reserve, which becomes the consolidated supervisor of large, systemically important banks.

This is like the fox guarding the henhouse. After all, the Fed’s overly loose money policies created the asset bubble -- including housing, commodities, and energy -- in the first place. Near-zero interest rates, huge money growth, and total disregard for the plunging dollar are what set up the housing boom and the unfortunate overleveraging by consumers, mortgage borrowers, and Wall Street securitizers.

It also set up the astronomical $150 oil shock, which came alongside the Fed’s overly tight money policies to offset the prior loose policies that would cause this credit crunch and deep recession. In fact, looking back to the last two bubbles -- the tech bubble of 1999-2000 and the housing/energy bubble after that -- it was the Fed’s pillar-to-post go-stop-go-stop lurches that deserve the principal blame for the economic messes that ensued.

The Great Moderation of the ’80s and ’90s has given way to extremism in Fed policy. And we may be in danger of repeating it all over again, with a new round of near-zero interest rates and a massive 11 percent growth of M2 over the past nine months.

There is one positive in the Obama plan: Sponsors of securitized asset-backed bonds will be forced to put 5 percent equity-skin in the game, in order to improve incentives for more appropriate risk and responsibility in lending. But it strikes me as somewhat ironic that the Fed would be placed in charge of systemic risk.

We also don’t know if any of the new regulations from the Obama White House and Treasury will deal with the moral-hazard question of “too big to fail” that was pointed out in Paul Volcker’s China speech last week. There will be new resolution authority to close down banks, but whether that will apply to the big banks remains to be seen.

Then there’s the new Consumer Financial Protection Agency. This provision was apparently written by liberal-left Harvard professor Elizabeth Warren, a staunch foe of free markets and an overzealous supporter of consumer-as-victim rights. Among its massive powers, this agency would enforce the Community Reinvestment Act, which has for years forced banks and other lenders to throw mortgage money at borrowers who cannot afford it. And the consumer protection would reach deep into bank supervision as well. What a mess.

Missing from the package is a reform that would put Fed monetary policy back on a commodity-price rule, including gold and the dollar. This rule was basically used from the early ’80s to the late ’90s, during Paul Volcker’s Fed term and the first half of Alan Greenspan’s term. This would have been the best-possible reform, but of course it’s not in the proposal.

So now the Fed has become the supreme Keynesian unemployment vs. growth Philips-curve tinkerer. Until this totally mistaken policy is changed, we can have ten more reregulation plans that will not fix the real problem.

COPYRIGHT 2009 CREATORS SYNDICATE INC.

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Views expressed in this column are those of the author, not those of Rasmussen Reports.