December 12, 2013

Rethinking the Federal Reserve's Many Mandates on its 100-Year Anniversary

Testimony Before the House Committee on Financial Services
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Chairman Hensarling, Ranking Member Waters, and members of the Committee, thank you for the opportunity to testify at today’s hearing. As the title of this hearing aptly notes, the Federal Reserve has many mandates. I will focus my remarks on only one of those—the regulatory mandate of the Board of Governors of the Federal Reserve System (Board). Specifically, I will briefly discuss the recent growth of the Board’s regulatory mandate, the adoption earlier this week of the Volcker Rule, and the Board’s persistent refusal to use economic analysis and other good government tools.

The Board's Increasing Regulatory Mandate

When the Dodd-Frank Act was being developed, one issue under consideration was whether the Board should lose some of its regulatory powers in view of its poor regulatory performance prior to the crisis. Instead, Dodd-Frank substantially increased the Board’s regulatory powers.1One of the most important new powers is the authority to regulate nonbank financial institutions designated systemically important by the Financial Stability Oversight Council.2So far, General Electric Capital Corporation, American International Group, and Prudential have been so designated, with additional entities likely to follow. These financial institutions will present the bank-focused Board with new regulatory challenges. It is important that the Board respond with well-vetted, tailored regulations that recognize that these entities are not banks and cannot be effectively regulated as if they were.

The Board also has new regulatory authority over other entities. These include financial market utilities (FMUs) designated by the Council. Two designated FMUs—The Clearing House Payments Company and CLS Bank International—are supervised by the Board, and it has back-up authority with respect to other FMUs. Dodd-Frank transferred regulatory authority over savings-and-loan holding companies from the now-defunct Office of Thrift Supervision to the Board.3Securities holding companies that opt for consolidated supervision will also be supervised by the Board.4Dodd-Frank also strengthened the Board’s regulatory hand with respect to bank holding companies and foreign banks operating in the United States. Time will tell how the Board exercises these authorities, but other regulators have expressed concerns about the Board’s unwillingness to recognize the role that these regulators already play in overseeing some of these institutions or their subsidiaries.” 5

Dodd-Frank also arms the Board with explicit mandates to consider financial stability, 6something that could be found by an imaginative or hopeful reader only “in the penumbra of the Federal Reserve Act” prior to Dodd-Frank.7Financial stability defies precise definition, which means that there are no clear constraints on how the Board can exercise this authority.

Despite the broad new grants of authority it now exercises, Board governors and other Federal Reserve officials have expressed an interest in accumulating additional regulatory authority. Areas of regulatory interest include money-market funds,8short-term securities financing markets,9and broker-dealers.10Sometimes the regulatory expansion is contemplated as the price of entry into the Federal Reserve’s safety net.11These officials should not be faulted for thinking broadly about potential risks in the financial markets, but implicit in these comments seems to be a belief that the Board’s regulatory reach must be comprehensive. There is a danger in having a single regulator that applies a uniform regulatory approach to the whole financial marketplace.12If that regulator is wrong, the entire market will bear the effects. Even if the regulator’s choices are reasonable, a common regulatory approach raises the risk of homogenization across financial institutions—and thus greater susceptibility to common shocks.

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