Dodd’s Plan Is the Key to Reshuffling Bank Oversight Power
Sen. Christopher Dodd, D-Conn., released a legislative draft that would take away the Federal Reserve and FDIC’s power to regulate banks and move it to a new federal bank regulator, while the Wall Street Reform and Consumer Protection Act of 2009 (HR 4173, introduced by Rep. Barney Frank, D-Mass.), would keep that authority with those agencies. Dodd’s plan makes better sense. Pro or con?”
Pro: FDIC Knows Best
For many reasons, the FDIC is better equipped to supervise banks than is the Federal Reserve, the Treasury Dept., or even a new "superregulator."
First, the FDIC has a unitary focus: the soundness and safety of the banking system. Unlike the Treasury and the Fed, the FDIC is not distracted with other responsibilities in the nation’s economy. Since its creation in 1933, the FDIC has had tens of thousands of man-years of experience closing failed banks and contending with the fallout of those banks. Only the FDIC has the requisite skills and experience needed to supervise the entire banking system.
The FDIC is an insurance company that thinks in terms of preventing losses to the insurance fund. Bank supervision has too long been the domain of agencies that care less about preventing losses and more about making banks highly profitable, thus creating an environment in which institutions "forum-shopped" for the supervisory agency that offered the best deal. The FDIC has every incentive to keep banks "in the middle of the road and out of the ditch on either side."
The FDIC was the only agency to sound the alarm early about the subprime crisis. The FDIC believes that, as Paul Volker says, "too big to fail is too big to manage." Neither the Fed nor Treasury has shown the courage to address too big to fail. As the FDIC has all the necessary skills already, a new "superregulator" would be redundant.
Con: Frank’s Plan Makes More Sense
Congress is now redrawing the financial regulatory landscape. The bills in the House and Senate share many features: They both aim to protect consumers from financial abuse; they protect against systemic risk; they alter the executive compensation process; they provide plans to handle bank failure; and they strengthen the securities regulator. But the bills differ in one main respect. The House bill would retain power and enforcement within the Federal Reserve, whereas the Senate bill shifts power to a new agency in which the FDIC would play a large role. So which is better?
In the House bill, the Federal Reserve’s primary role is to determine interest rates and the size of the money supply, but it also regulates and supervises banks. The Senate bill robs the Fed of this second function. But as this last crisis showed, banks are central to the macroeconomy. Thus information relevant to bank regulation is also relevant to setting interest rates. It is efficient to keep all this information in the same house, rather than coordinating across many agencies in the same neighborhood.
The independence of the Fed insulates it from the political bias that affects most government agencies. And the Fed’s cadre of skilled economists provides the technical competence for managing systemic risk. For sure, the Federal Reserve must bear some blame in the buildup of the crisis. But the solution is to restructure the existing infrastructure of the Fed—rather than transfer that responsibility to the FDIC or face the massive uncertainty that attends the birth of every new government bureaucracy.