[IMGCAP(1)]It is widely believed that the U.S. financial system needs asystemic risk regulator to help prevent future financial crises. Thedebate is centered not on whether we should have such a regulator, butwhich agency should be anointed and what powers it should have.
I was skeptical about a systemic risk regulator when itwas first proposed, because the proposal was for the Federal Reserve tobe the regulator. I believe that would be unwise for two reasons.
First and foremost, I do not believe any single agency hasthe wisdom and experience to perform the job. Second, I see anoverwhelming need for a strong and politically independent FederalReserve System, and I believe it would not be in the Fed's bestinterests to undertake this assignment. The chances of something goingawry in the system are simply too great for the Fed to risk itsreputation and political independence in this fashion.
Currently there are at least four government agencies (theFederal Reserve, the Treasury, the Federal Deposit Insurance Corp. andthe Securities and Exchange Commission) on which we rely to maintainorder and stability in the financial system. Each approaches the taskfrom a different perspective and each has different strengths andweaknesses. We need to bring these agencies together and get them moreacutely focused on potential systemic risks.
I believe a Systemic Risk Council, composed of at leastthese four agencies and possibly others, is the best approach. Thecouncil would meet monthly to consider the condition of the financialsystem and any potential threats to it.
The council would have dedicated staff - probablynumbering in the hundreds - tasked with gathering and analyzing dataand trends around the world and making recommendations for possibleregulatory or legislative actions. The council would not be aregulator, but it would have broad authority to collect data fromgovernment agencies and to require those agencies to gather and provideinformation from the firms that they oversee.
The council would have the authority to block or overturnany regulations that it believes could threaten the stability of thefinancial system. For example, the Basel II capital regulation, whichis highly pro-cyclical and was originally intended to allow reductionsin large-bank capital levels, would be subject to review by thecouncil. The council could also review the system of assessing depositinsurance premiums, which currently charges minimal premiums in goodtimes and drains capital from the banking system in difficult times.The council could be given the authority to approve the FDIC's use ofextraordinary powers during times of financial emergency, in lieu ofthe current system, which vests that authority in the Treasury inconsultation with the president.
The SEC currently has oversight authority with respect tothe Financial Accounting Standards Board, which promulgates accountingrules. This oversight authority could be transferred from the SEC tothe council to ensure that accounting standards are not adopted withoutconsideration of the potential systemic effects on the financialsystem.
For example, accounting rules allowed the creation ofoff-balance-sheet special-purpose vehicles that resulted in increasedleverage and risks in the financial system. Now that we are in themiddle of a financial crisis, FASB is proposing to put those vehiclesback on the books of banks, which will reduce their capital ratios andtheir ability to lend. These and other accounting rules are far tooimportant to be left to accountants without proper governmentoversight.
The chairman of the Fed could be chairman of the council.I do not favor this approach because I do not believe the councilshould be dominated by one agency. Another possibility is a rotatingchairmanship, similar to that of the Federal Financial InstitutionsExamination Council. I do not favor this idea because it would resultin a weakened council, lacking in stature.
I believe the best approach would be for the chairman ofthe council to be a presidential appointee confirmed by the Senate fora six-year term. This would give the council the profile and stature itwill need to do its job properly.
A Systemic Risk Council structured along these lines wouldenhance significantly the oversight of the financial system and helpavoid crises like those we experienced in the 1980s and are mired intoday. It would bring to bear the diverse experience and resources ofthe existing independent regulatory agencies without suffocating orfurther politicizing our financial system.
William Isaac is a former chairman of the Federal DepositInsurance Corp., and now chairman of global financial services forconsulting firm LECG.
(c) 2009 Accounting Today and SourceMedia, Inc. All Rights Reserved.
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