Federal Reserve Chairman Ben S. Bernanke urged a sweeping overhaul of U.S. financial regulations in an effort to smooth out the boom-and-bust cycles in financial markets.
“We should review regulatory policies and accounting rules to ensure that they do not induce excessive” swings in the financial system and economy, the central bank chief said today in remarks prepared for an address to the Council on Foreign Relations in Washington.
Bernanke recommended that lawmakers and supervisors rethink everything from the amounts firms set aside against potential trading losses and deposit-insurance fees to protections for money-market funds. His remarks reflect a judgment that the U.S., just like emerging-market nations in the past, failed to properly manage a flood of capital over the past decade and a half.
Bernanke also reiterated his call for an agency to take on overarching responsibility for financial stability. While he didn’t specify which regulator should take that job, he noted that the Fed was first formed to address banking panics and said the initiative would “require” some role for the central bank.
Congress and the Obama administration are embarking on the broadest revamp of the oversight of U.S. finance since the Great Depression. Bernanke’s speech marks the Fed’s contribution to the policy debate.
Rival Regulators
Analysts are skeptical that the Fed will be the sole agency to emerge with more supervisory powers because Congress has been critical of the Fed’s regulatory oversight as the crisis grew.
Politicians and the public will “ask what was the Fed doing not only in 2007 and 2008, but what was it doing in 2005” during the credit boom, said Dino Kos, managing director at Portales Partners LLC in New York, and a former markets director of the New York Fed.
A system of multiple regulators “is in place for a reason, and it will be tough to overcome some of those political and jurisdictional battles,” said Timothy Adams, a former U.S. Treasury undersecretary in the administration of George W. Bush and managing director of the Lindsey Group in Fairfax, Virginia.
The Fed chief also reiterated that the central bank, U.S. Treasury and other regulators “will take any necessary and appropriate steps” to ensure banks have capital to “function well in even a severe economic downturn.”
‘Forceful’
“Governments around the world must continue to take forceful and, when appropriate, coordinated actions to restore financial market functioning and the flow of credit,” Bernanke said today. “Until we stabilize the financial system, a sustainable economic recovery will remain out of reach.”
Referring to the stress test regulators will use to determine whether banks need more capital, Bernanke said an adverse scenario “involves unemployment averaging over 10 percent for a period, which we view as certainly well within the realm of possibility.” That outcome isn’t the “central tendency” of most forecasts, he said in response to an audience question.
Among the biggest challenges faced by regulators is addressing the issue of banks that are so big and interconnected with other firms that their failure would put the entire banking system at risk.
Bernanke said firms that are too big to fail are “an enormous problem.” Large firms will require “especially close” oversight in the future, he said. Regulators need the authority to seize such firms, such as the Federal Deposit Insurance Corp. already has for deposit-taking institutions, he said.
Money Funds
Among other changes, Bernanke urged steps to protect against an outflow of money from money-market mutual funds, and said one market where banks and securities firms finance themselves -- known as the triparty repo market -- may need to move to a central clearing system.
“Given how important robust payment and settlement systems are to financial stability, a good case can be made for granting the Federal Reserve explicit oversight authority for systemically important payment and settlement systems,” Bernanke said.
The Fed chairman also called for a review of accounting and capital guidelines that may cause banks to pull back in downturns.
“We should review capital regulations to ensure that they are appropriately forward-looking, and that capital is allowed to serve its intended role as a buffer -- one built up during good times and drawn down during bad times,” the chairman said.
Accounting Changes
“Further review of accounting standards governing valuation and loss provisioning would be useful, and might result in modifications to the accounting rules that reduce their pro- cyclical effects,” Bernanke said.
Asked about rules that require companies to value some investments at their current market values, Bernanke said “I strongly endorse the basic proposition of mark-to-market, which is that we should make our financial institutions’ balance sheets as transparent, as clear as possible.” He added that he “would not support any suspension of mark-to-market.”
Still, in periods of financial stress, when some markets don’t exist or are highly illiquid, “the numbers that come out can be misleading or not very informative,” Bernanke said. Regulators could provide “guidance” on reasonable ways to value assets, he said.
‘Systemic Risk’
U.S. lawmakers, while agreeing on the need for federal supervision of “systemic risk,” have yet to agree on which agency should assume that role and its necessary statutory power.
Representative Barney Frank, a Democrat and chairman of the House Financial Services Committee, said last month he plans by April to release a draft of legislation designating the Fed as the overseer.
Senate Banking Committee Chairman Christopher Dodd voiced doubt last month that the central bank is up to the task, calling its regulation and consumer protection “abject failures.”
“The question is whether we should be giving you a bigger plate, or whether we should be putting the Fed on a diet,” Dodd told Bernanke at a hearing last month, noting that monetary policy should remain the Fed’s top priority.
“When you keep asking an agency to take on more and more, it becomes less and less likely that agency will succeed at any of it,” said Dodd, a Democrat from Connecticut.
The Fed supervises about 900 state banks and is the primary regulator for bank holding companies. The Fed also writes consumer protection rules and has the final word on proposed mergers among bank holding companies.
Obama Plan
Bernanke’s comments come as the White House prepares a proposal for regulatory change. President Barack Obama has asked his economic team to shape legislative proposals within weeks.
The global financial crisis stemmed in part from a failure by government supervisors to accurately measure risk-taking by financial institutions and the ability of lenders and investors to exploit loopholes in oversight, regulators have said.
A review of financial regulators worldwide yields “no obvious model of success,” Robert Eisenbeis, chief monetary economist at Cumberland Advisors Inc. and former director of research at the Atlanta Fed, said yesterday. The task “will fall to the central bank because they are the only institution that has the unlimited resources to step in and do what needs to be done.”
Paul Volcker, an Obama adviser and former Fed chairman, called in January with other members of the Group of Thirty for a regulatory crackdown curtailing risk-taking by large financial institutions and limits to their share of deposits.
Led by Volcker, the panel of former central bankers, finance ministers and academics said regulators should impose capital limits on proprietary trading and bar large banks from running hedge funds.
