Last week, likely Democratic nominee Hillary Clinton committed her presidential campaign to the push by Sen. Elizabeth Warren (D-Mass.) and other congressional progressives to make, as a spokesperson noted, the Federal Reserve “more representative of America as a whole.” These reformers insist that the Federal Reserve will be more publicly accountable if its governing boards, which are currently dominated by white men from the financial and corporate sectors, included more women, people of color as well as labor and consumer voices.
A more accountable Fed would be good for both the financial markets and the nation as a whole. But changing who sits on the Fed’s regional bank boards will not be enough to avert the next financial crisis. And make no mistake, without a change in course from Congress and the White House, a new crisis is coming. Nearly a decade after the financial crisis that brought the Great Recession, Wall Street has too many cops, each with too little power, tied up in knots with each other. And the Fed remains the top cop of all, with a major conflict of interest: a mandate to both police the market and to encourage it.
Today, the economy is doing relatively well, and the financial markets appear to be doing fine. It’s easy to fail to get ready for a storm when the sun is shining. But a storm will come. Not worried about this? You should be.
A little recent history explains how we got to this point.
After the crisis of 2008, then-Sen. Chris Dodd (D-Conn.) started his push for reform of finance with a telling question: “Why does the Fed deserve more authority when institutionally it seems to have failed to prevent the current crisis?” After all, the Fed had failed its responsibility for oversight before 2008. Not only that, in a story we tell in our book, “Fed Power: How Finance Wins,” the central bank secretly pursued massive rescues in 2009, going well beyond the bailout authorized by the TARP (Troubled Asset Relief Program) law passed by Congress.
And the failures of 2008 were far from the first major errors of the Fed and other financial regulators.
Appalled at the Fed’s failure, Dodd’s initial interest was to reduce the Fed’s regulatory power. He ran into opposition he could not overcome.
The tag team of the Fed and its allies in finance defeated Dodd’s goal of a stronger regulatory structure independent of the Fed. Dodd shifted strategies. If he couldn’t roll back the Fed’s power, he would counteract it by taking a page from James Madison’s playbook of checks and balances. Dodd recast financial oversight to ensure that no one agency would be able to act alone without others monitoring or checking.
Take the most significant new authority the Fed was given under the Dodd–Frank Wall Street Reform and Consumer Protection Act: the power to take actions to stop runs on systemically important, so-called “too big to fail” financial institutions that threaten the entire economy. This new responsibility was shared, however, with an unwieldy new Financial Stability Oversight Council and its 10 voting members.
The new responsibility for consumer protection is in some ways similar. It is housed in the Fed and strapped to a similarly unwieldy structure with a host of federal and state regulators. Dodd-Frank created new authorities to fend off another financial crisis, but it ensured that it would be difficult to exercise, especially under dire circumstances.
Generations of academic research on regulation and administration suggest a predictable outcome. Dodd-Frank’s efforts to ensure that agencies will watch and check each other are likely to produce agency rivalry and administrative confusion.
To be fair, Dodd-Frank made significant headway. The creation of the Consumer Financial Protection Bureau bolstered consumer protections against the deception of companies selling dodgy mortgages, unsustainable credit cards, unaffordable student loans and other financial products to borrowers with inadequate resources. And Dodd-Frank forced firms to have more cash and credit to cover their loans and investments.
Yet big-market investors, government leaders and regular citizens alike are right to be concerned about Dodd-Frank’s diffusion of regulatory power, because it saps government of the capacity and coherence it needs to prevent the next crisis.
But wait a moment: Is there anything that could be done to end the financial markets’ cycle of crisis?
Yes. Consider Canada. Canada shared America’s topsy-turvy financial history until it committed several decades ago to get serious about stopping financial breakdown. Canada created a regulatory structure with fewer agencies, clearer lines of authority and simpler rules. Importantly, the Bank of Canada, the nation’s equivalent to the Fed, has a far more focused role and less extraordinary power than the Fed does. Sure enough, Canada averted the 2008 crisis, stopped the spread of the financial contagion on its southern border and avoided the massive taxpayer bailout forced on Americans.
So what comes next? First, GOP leaders and the White House would be wise to get behind the Clinton-Warren push. Bipartisan reform is all too rare today. But making the Fed accountable to more regular Americans — read: people who do not work in the financial services industry — would be a critical step forward.
Here are two more steps.
For starters, the Fed needs to be shorn of its ever-expanding portfolio of regulatory and even fiscal responsibilities. It should be returned — as the Bank of Canada has been — to its essential function of managing the supply of money.
A second step is to consolidate financial administration. Following Canada’s financial crisis in the 1980s (its last), the Canadian government created a new regulatory institution known as the Office of the Superintendent of Financial Institutions (OSFI). This body consolidated the disparate regulatory agencies of banks, capital markets and insurance. It used its authority to determine whether the operations of large financial institutions were sound, and it singled out unstable firms for possible closure or remedial action. The Office thwarted, for instance, the American-style expansion of sub-prime mortgages as traded securities, a culprit in the 2008 crisis.
A respected international watchdog, the Financial Stability Board, has regularly praised Canada’s financial management for its effectiveness in policing against risky speculation. By comparison, this same independent watchdog complained that America’s “complex and fragmented” administration has proven ineffective in deterring excessive risk-taking and fending off threats to the financial system.
America’s greatest governmental reforms have always married public accountability with sound administration. The Fed needs both.
Lawrence R. Jacobs and Demond King are the authors of “Fed Power: How Finance Wins” (Oxford University Press, April 2016).
This article was first published at The Hill.