Issue of the week: Should the Fed be a super-regulator?

Say this for President Obama’s sweeping new proposal for regulating financial institutions: “It makes no stupid suggestions,” said Clive Crook in the Financial Times. His overhaul avoids the “regulatory backlash” of the Sarbanes-Oxley law, which imposed onerous reporting requirements on corporations after the Enron scandal in 2002. But the president’s skeletal plan is less a proposal than the outline of a proposal. It would require lenders to retain a piece of every loan they sell; hedge funds to register with the federal government and submit to its scrutiny; and derivatives to be traded on a central exchange. But his most controversial proposal is for the Federal Reserve to be responsible for the well-being of the entire financial system, not just individual institutions. Should the actions of a big financial player put the system at risk, the Fed could swoop in and shut the institution down “in an orderly way, rather than facing the choice of bailing it out or letting it collapse and maybe drag others down with it.” Those are all laudable aims, but Obama has left the details to Congress. That doesn’t inspire confidence.

Obama’s plan fails “to embrace the basic truth that profit and loss are the best, most effective regulators of all,” said John Tamny in Forbes. Left to the market’s own devices, the institutions that take excessive risks will collapse and “healthy substitutes” will rise in their place. But instead of allowing the market to cleanse itself, Obama wants the Fed to run the show, and prevent future collapses. Yes, the same Fed that allowed the housing bubble to inflate and let banks gamble away their capital is now supposed to oversee the entire financial system. “A bureaucracy that was utterly blind to the proverbial trees will now be asked to somehow see the forest.”

I’m less worried that the Fed can’t see out than that we can’t see in, said William Greider in The Nation. Before giving the central bank any additional powers, Obama needs to dismantle its “privileged secrecy and intimidating mystique.” That’s why it’s heartening that about 230 members of the House have endorsed a proposal to have the Government Accountability Office audit the Fed as if it were just another federal agency. “The power of financial titans and the Fed depends crucially on public ignorance.” Shedding light on the Fed’s “murky power” would be the best reform Washington could enact.

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What is it about the Fed that “brings out Illuminati-style, black-helicopter paranoia in the American psyche?” asked James Ledbetter in Slate.com. Its secrecy isn’t really so sinister. “By design, the Fed is largely independent of other branches of government” to ensure that its policy deliberations are untainted by political considerations. That’s all. And it’s only logical that the Fed should be the systemic regulator—after all, it trades securities with financial institutions every day, giving it unique insight into the markets. Still, if the administration “has to shine a bit of sunlight into the Fed’s dungeon” in exchange for additional oversight powers, that’s a price worth paying.