Fed Rules

Linda Chavez
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Posted: Jun 19, 2009 2:04 PM
Fed Rules

One of the great dangers in dealing with a crisis is making major, long-term decisions based on the immediate circumstances unique to the problem you're trying to fix. In the case of the current financial crisis the conventional wisdom is that it is the result of poor oversight and loose regulation, so the Obama administration's answer is to layer on more regulations and greatly expand the role of the Federal Reserve. But the cure may be worse than the disease.

It's not often I agree with Democratic Senator Chris Dodd, but he hit the nail on the head when he suggested the Obama plan to give vast new regulatory responsibility to the Fed "is like a parent giving his son a bigger, faster car right after he crashed the family station wagon."

The president's plan would turn an agency whose historic role has been to set monetary policy into a new superagency whose job it would be to oversee any institution that has the potential to adversely affect the overall economy, including large insurance companies, hedge funds and investment banks. But adding these new areas of regulatory oversight not only concentrates enormous power over the economy in a single body but would divert attention from the important monetary function the Fed now plays: namely, control of the nation's money supply.

The administration's plan is the brainchild primarily of two men: Treasury Secretary Timothy Geithner and the director of the National Economic Council Larry Summers. Geithner's previous job was as head of the Federal Reserve Bank of New York, so it's not surprising he thinks the Fed deserves even more power. On the other hand Summers, who was Bill Clinton's Treasury Secretary, may want to make up for past sins. He has been the beneficiary of largesse from some of the very Wall Street firms at the heart of the current financial mess. According to disclosure forms he filed when he joined the administration, as reported in Salon magazine, Summers earned more than $2.7 million in speaking fees in 2008 alone from Goldman Sachs, Merrill Lynch, Lehman Brothers, Citigroup, and other troubled firms.

If the administration gets its way, the Fed will have greatly expanded authority to decide which institutions it would regulate. This week, even the plan's authors seemed unsure which institutions would come under greater scrutiny and oversight, with Geithner claiming the plan wouldn't regulate hedge funds and Summers saying it was too early to tell. But the administration's "blueprint" for reform lays out broad criteria that include an institution's size, leverage, and reliance on short-term funding; its role as a source of liquidity for the financial system; the impact a potential collapse might have on the financial system; and whether the institution was a source of credit to homeowners, businesses, and governments.

The definitions provided by the administration are so broad they could include not just institutions like insurance giant American International Group, the investment firm Goldman Sachs, and other firms whose near collapse last year precipitated the financial crisis but virtually any large institution whose business model includes providing financing to just about anyone.

The public is growing increasingly skeptical, however, whether the Obama administration's far-reaching intrusion into the private sector is a good idea. The latest Wall Street Journal poll shows nearly 70 percent of Americans have reservations about the government's recent interventions in the economy, and President Obama's approval ratings have fallen. Overall, he's slipped from a 61 percent approval rating in April to a 56 percent rating now, and a bare majority of Americans, 51 percent, now approve of his handling of the economy.

Poll numbers like these may explain why the president's plan has already drawn fire from Democrats like Dodd as well as Republicans. Congress may yet put the brakes on the Obama plan. If not, the Federal Reserve's growing tentacles could end up strangling the U.S. economy in the name of protecting it.