Credibility is an enormous asset. Once earned, it must not be frittered away by yielding to the notion that a “little inflation right now” is a good thing to release animal spirits among entrepreneurs and to pep up investment. The implicit assumption behind that siren call must be that the inflation rate can be manipulated to reach economic objectives—up today, maybe a little more tomorrow, and then pulled back on command. But all experience amply demonstrates that inflation, when deliberately started, is hard to control and reverse. Credibility is lost.
I have long argued that concern for “stability” by central banks must range beyond prices for goods and services to the stability and strength of financial markets and institutions generally. I am afraid we collectively lost sight of the importance of banks and markets that would robustly be able to maintain efficient and orderly functioning in time of stress. Nor has market discipline alone restrained episodes of unsustainable exuberance before the point of crisis. Too often, we were victims of theorizing that markets and institutions could and would take care of themselves.
I expressed my concerns in that respect when I was chairman of the Fed; and their relevance to central banking and the organization of regulatory authority were more fully expressed several years ago. Congress was then beginning to consider reform legislation. It was recognized that regulatory agencies, perhaps most specifically the Federal Reserve, had exhibited a certain laxity and ineffectiveness in the period leading up to the financial breakdown of 2008, particularly with respect to the mortgage market.
Nevertheless, the provisions of the Dodd-Frank Act of 2010 implicitly recognized and even reinforced the range of Federal Reserve regulatory and supervisory authority. To that end, it provided for a new vice-chairman of the board specifically charged with responsibilities for bank supervision. (Apparently one governor has in practice undertaken that substantial role, but for some reason after almost three years the specific position of vice-chairman remains unfilled. That lapse unfortunately leaves open the question of whether the administration and the Federal Reserve really appreciate the long-term significance of maintaining the Fed’s supervisory responsibilities.)
The Dodd-Frank Act does establish a new Financial Stability Oversight Council, a coordinating mechanism chaired by the Treasury. However, the regulatory landscape has been little changed. The result is that, following Dodd-Frank, we are left with a half-dozen distinct regulatory agencies involved in banking and finance, each with its own mandate, its own institutional loyalties and support networks in Congress, along with an ever-growing cadre of lobbyists equipped with the capacity to provide campaign financing.
I will not take the time to elaborate on all of the evident frictions and overlapping responsibilities. But here we are, almost three years after the passage of Dodd-Frank, with important regulatory and supervisory issues arising from the act unresolved. Those include the prohibition on proprietary trading by banks—especially close to my heart—and certain aspects of trading of derivatives.
Beyond Dodd-Frank, a seeming consensus among the agencies and the Treasury on reform of money market mutual funds still has not resulted in satisfactory action even though no new legislation is required. A recently announced proposal by the SEC has been to require mark-to-market accounting for some funds. Such accounting requires that the value of assets be based on their current market prices, and not on historical cost accounting. That proposal, if accepted, will go only part way. Similarly, progress toward international accounting standards is stalled and no meaningful reform of the credit-rating agencies has been undertaken.
I know these issues raise old questions of regulatory organization, some of them apparent fifty years ago. I also know some of the current issues are complex and call for highly technical judgments. But none of that mitigates the fact that the current lack of agreement on key regulations and their enforcement is simply unacceptable to the financial industry, as well as harmful to effective governance. We also know that the present overlaps and loopholes in Dodd-Frank and other regulations provide a wonderful obstacle course that plays into the hands of lobbyists resisting change. The end result is to undercut the market need for clarity and the broader interest of citizens and taxpayers.
The simple fact is the United States doesn’t need six financial regulatory agencies—the Fed, the SEC, the FDIC, the CFTC, the Federal Housing Finance Agency, and the Office of the Controller of the Currency. It is a recipe for indecision, neglect, and stalemate, adding up to ineffectiveness. The time has come for change.
As things stand today, I am told that can’t happen and won’t happen. However powerful the arguments for action, the vested interests—within the agencies, in Congress, and outside—are just too strong.
I ask, can we let that view stand unchallenged? Permit me to look back once more, a half a century ago, for inspiration. Then, faced with similar issues about financial markets, monetary policy, and regulation, with unanswered questions and political pressures from left and right, two special inquiries were launched. The first was by Congress itself. A few years later an extensive review entirely sponsored by the private sector was undertaken. Both were well financed and staffed, with highly responsible leaders. In the Senate, there was Senator Paul Douglas, a well-known economist, who provided leadership and chaired the inquiry by the Joint Economic Committee. Frazer Wilde, a public-spirited, highly respected insurance company executive, chaired the private Commission on Money and Credit.
I recall from my then limited perch that the Federal Reserve was, true to its name, reserved, fearing that its independence and authorities might be questioned. Moreover, it’s easy to look back and find that most of the specific and detailed recommendations of the two inquiries—including proposals to consolidate the regulatory agencies—never were acted upon.
However, something crucially important was achieved. The result was to reinforce the rationale for Fed independence at a time when that was not taken for granted. Both extreme “populist” and “liberal” views about monetary policy and the organization of the Federal Reserve were rejected. The need for adequate resources and able staff for all the regulatory agencies was strongly supported. More broadly, a growing role for active countercyclical fiscal policy was advocated when that was not yet commonly accepted.
Can we replicate that process today? Can strong ideological and political divisiveness in the present Congress be overcome, along with the baleful influence of the constant search for campaign financing? I don’t know. I do sense a risk of a quite different kind of inquiry emerging, one with a preconceived mission of limiting Federal Reserve independence, restraining needed financial regulation, and conducting radical surgery on the financial system.
Let’s reject a meat-ax approach. Much better that the president, congressional leaders, and interested and responsible business and academic experts together support something constructive: a well-coordinated, adequately financed inquiry bringing together the legitimate public and private interests.
The erosion of confidence and trust in the financial world, in the financial authorities that oversee it, and in government generally is palpable. That can’t be healthy for markets or for the regulatory community. It surely can’t be healthy for the world’s greatest democracy, now challenged in its role of political and economic leadership.
Instead of complaining, let’s do something about it—something that can in its own way help restore a sense of trust and confidence that is so lacking today.