Tuesday, June 16, 2009

Meltzer in the WSJ on the Fed as regulator and more

Meltzer Article

In his WSJ commentary Allan Metlter mostly is critical of the Fed and of its performance as a regulator. He is clearly in that group that is not happy to see the Fed emerge from the New Obama plan with more powers, as seems to be the case.

Meltzer is critical of the Fed on the record. Others are critical of the fact that should the Fed get this job its mission will be diverted and its attention will be split between regulating and making monetary policy. Still others argue that the Fed did not see this coming and should not be rewarded with more power. But no regulator did see it coming. By that standard the comprehensive regulator should be something altogether new. Having an untested agency does seem like a good idea to me.

Meltzer is critical of the past. Under Alan Greenspan the Fed was not aggressive. But that was Greenspan's leadership, not the Fed bureaucracy. Greenspan was the classic regulator who did not believe in regulating. He was the problem, not the Fed. The Fed, viewed as an institution, spotted some of the bank problems and sent requests for action up the line. Greenspan blocked the Fed from taking action. That's a personality/ideology problem not an institutional problem. . To me it suggests that the Fed has hope. Obviously having a leader with the right instinct matters. Under Greenspan, the Fed did not. But the SEC did not get it and neither did other regulators. The Fed at least comes close. Politics intervened, rearing its ugly head in the the house financial services committee. There members urged more of the sort practices that ultimately became toxic in an effort to spread the housing miracle to everyone. That is an argument for keeping the politicians out of it. I still am not sure if some of the state/federal conflicts are being handled. Some mortgage brokers used to engage in illegal activities then fall back across state lines and open for business again. Has this loop-hole been closed?

Meltzer blames the Fed for dawdling and for the $150 bln in losses in the thrift crisis in 1980-1982. That seems disingenuous. Those losses came about because of monetary policy mistakes coupled with interest rate ceilings. When those rate ceilings were taken off banks and thrifts had low yield assets on their books. When the Fed shftied to new operating procedures in October of 1979, that drove rates to 20%. Banks were caught in a no-win situation. If that was the Fed's fault it was not the fault of the Fed as regulator. For a bank that thought an 8% yielding asset was a good one, the Fed's monetary policy move was a disaster as rates moved up and stayed up.
The thrift crisis was compounded by the Fed as regulator when it gave thrifts powers to execute C&I loans when even though they had no experience with that sort of lending. Banks that already were on death's doorstep were all but encouraged to play the game of moral hazard otherwise known as double or nothing.

Meltzer also is concerned and critical of teh Fed for not having a policy on closing banks. When banks get in trouble they do not know what to expect. The Fed in fact does not close many of them. Small banks are closed all the time by the FDIC. The Fed is more reluctant. It is good about enforcing the rules but bad at deciding what to do when a large bank is tottering. More often than not the Fed's prescription is that its Merger Time.

Even so I don't think any of that history disqualifies the Fed. Large banks are not small bank sand they bring different problems to the table. The failure of the investment bank Lehman Bros. must have made that clear.

There is no panacea to this problem. There may not be a 'right' answer as much as there are different ways to play it and different risks to take. The Fed proved itself historically to have been a bit lenient toward banks. But it's not clear that the Fed, armed with a broader mandate would be the same sort of regulator as it once was. Some politicians have a preference for putting the risk assessment center at Treasury directly where there is both political accountability and the greater potential for political meddling.

As a matter of logic it seems to me that someone will do this job. If the job is put under the Fed's purview is it any different than if it is put anywhere else? Could Bernanke have a second under him who is mainly concerned with matters of regulation? Why would such a thing have to interfere with making monetary policy? Arguably, knowing more about the regulatory picture could make the Fed better at monetary policy. But heaping more duties on a quasi-governmental organization has its costs and risks too. While many like the Fed for its independence, when it starts shutting banks down, the first to squeal are the politicians themselves. Does than man that they would have meddled?

The whole thing is a slippery slope. Whoever becomes the super regulator he will need to close the loopholes and the gaps between regulators that used to exist and deal with the threat from derivatives. We need to get away from regulatory competition. And we need to do better job than we have to date. That is true of the banking committees with their oversight responsibilities and all regulators of any sort. It would help if financial managers did a better job too.

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