More Regulatory Power for the Federal Reserve?

There’s been time… a lot of time. Yet, two years after the collapse of Lehman Brothers, Congress is still introducing various potential regulations in the hopes of keeping yesterday’s problems from occurring again in the future. The latest bill from Senator Chris Dodd (D-CT) is positioned to put just a little “bit more power” into the same oh-so-capable hands that failed the last time around… the Federal Reserve.

According to The Washington Post:

“Before the Great Depression, bank runs were an all-too-common occurrence. There were dozens in the years leading up to 1929. FDR’s response wasn’t to create a Commission on Bank Runs, tasked with watching banks and stepping in to insure their deposits if they got into trouble. He insured all consumer deposits. It didn’t matter whether the chairman of the Federal Reserve thought your bank was playing nice. Your money was safe, even if he got it wrong. If you want proof of how well it worked, ask yourself this: Did you line up outside your bank to close your account after Lehman Brothers collapsed?

“The corollary today is capital requirements. When Lehman went down, its leverage was about 30:1. That means it had borrowed $30 for every dollar it had in assets. Leverage that high does a few things. First, it gives the bank more money to take risks, which banks like because it means higher profit. Second, it means that the bank has less money to pay back creditors if a bunch come calling at once, making failure more likely. Third, it means that if the bank does go down, it does more damage to the system because there are more people counting on the bank to pay them back.

“Keeping capital requirements at manageable levels is financial regulation’s killer app. But Dodd’s bill doesn’t spell out manageable levels. Instead, it leaves that up to regulators (mostly at the Federal Reserve) and gives them a bit more power to impose such requirements. ‘That’s the story the regulators want to tell, that they just needed more tools,’ sighs Richard Carnell, a former assistant secretary of the Treasury for the financial market. ‘But they can set capital requirements now. They had ample tools, and they lacked the prescience and will to use them.’”

With Dodd’s proposed bill it looks like very little would change. One more time the ever-vigilant Fed could be entrusted with new power and additional discretion to mismanage coming economic crisis. At least we’ll have a better sense next time around… about how few sound decisions we can expect.

You can visit The Washington Post to read more about why we can’t rely on financial regulators to protect us.

Rocky Vega,
The Daily Reckoning

The Daily Reckoning