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Supervisory power is critical to Fed

Politico

By Ernest T. Patrikis and John R. Dearie

On Dec. 11, the House Financial Services Committee passed a financial reform bill that would preserve and even expand the Federal Reserve’s role as a supervisor of large financial institutions. In the Senate, meanwhile, a consensus has reportedly emerged that the Fed should be stripped of all supervisory powers. Doing so would severely undermine the strength, effectiveness and credibility of the world’s premier central bank, with very negative implications for the stability of the U.S. financial system and, therefore, the productive capacity of the U.S. economy.

The apparent consensus among most Senate Banking Committee members seems to be based on two principal notions: first, that the Fed’s supervisory record during the recent financial crisis was one of utter failure; and second, that supervisory duties are a burden to the Fed and distract the central bank from its “core” responsibility as the monetary authority and lender of last resort. Both notions are incorrect and should not drive policymakers’ reform deliberations.

The notion that the Fed is a supervisory failure is refuted by the facts. Most of the notorious names of the recent crisis — Bear Stearns, Lehman Brothers, Merrill Lynch, Countrywide, Washington Mutual, IndyMac, American International Group, Fannie Mae and Freddie Mac — were not supervised by the Fed, at either the subsidiary or the holding-company level. 

The Fed supervises state-chartered banks that are members of the Federal Reserve System and all bank holding companies. Of the more than 5,500 BHCs supervised by the Fed, only two sustained losses during the crisis that threatened their survival. Indeed, three of the largest Fed-supervised BHCs served as instruments of stabilization and recovery by absorbing other failing institutions — Wells Fargo absorbed Wachovia; JPMorgan Chase absorbed Bear Stearns and Washington Mutual; and Bank of America absorbed Countrywide and Merrill Lynch. 

In 2009 and 2010, about 100 FDIC-supervised banks, 30 OCC-supervised banks and 25 OTS-supervised thrifts failed, compared with just 17 Fed-supervised banks. This is not to argue that any particular supervisor is better than the others — all performed at subpar levels, and significant improvement is necessary. But characterizations of the Fed as a “supervisory failure” are demonstrably incorrect.

The argument that supervisory activities overburden or distract the Fed from its primary duties is equally spurious. Far from a distraction, supervision is consistent with and supportive of the Fed’s critical role as the monetary authority and lender of last resort for the very simple and straightforward reason that financial institutions are the transmission belt of monetary policy. 

 

Firsthand knowledge of the activities, condition and risk profiles of the financial institutions through which it conducts open-market operations — or to which it might extend discount window lending — is critical to the Fed’s effectiveness as the monetary authority. Indeed, we suggest that Congress consider creating a second vice chairman for the Federal Reserve Board, who would be nominated and confirmed to head the Fed’s supervisory program.

The Fed also has unrivaled institutional experience as a supervisor. It has been a supervisor of financial institutions since its creation by Congress in 1913, has supervised bank holding companies since those entities first became subject to federal supervision in 1956 and was designated by the Gramm-Leach-Bliley Act of 1999 as the “umbrella supervisor” of financial conglomerates that include banking, securities and insurance entities.

U.S. policymakers should also be mindful of international trends. In the United Kingdom, serious consideration is being given to shifting bank supervision back to the Bank of England, and in Germany, the new coalition government announced in October that significant supervisory powers would be shifted to the Bundesbank from the financial market regulator, known as BaFin.

Americans are justifiably angry about the financial crisis and its impact on the broader economy. The Fed is a convenient target, given the central role it played in combating the recent financial crisis. But punishing the Fed would be like attacking the fire department for water damage caused while saving the neighborhood from a catastrophic fire. More fundamentally, the goal of financial reform is a supervisory framework that makes our financial system more stable, flexible and resilient. Achieving that goal requires a central bank that is strong, effective and credible — and supervisory power is essential to that important objective.

Ernest T. Patrikis, a partner at White & Case LLP, spent 30 years at the Federal Reserve Bank of New York, serving as general counsel and later as first vice president and chief operating officer. John R. Dearie served in the Bank Supervision Group of the Federal Reserve Bank of New York from 1990 to 2000.

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