U.S. Fed - Equivalent of ECB - Emerges Strengthened in Crisis Financial Reform     Print
J. Paul Horne

Despite populist pressures to curtail its powers, the U.S. Federal Reserve System is now certain to remain fully independent of direct political interference in setting U.S. monetary policy. Moreover, its supervisory and regulatory powers will be extended to non-bank financial institutions (although it will have to work more collegially with other Federal regulators in this area).

This is the upshot of the Senate’s solid bipartisan approval of the reform bill led by Senator Christopher Dodd -- the most important changes in regulation of the financial industry since the Banking Act of 1933. The legislative process is now on track to become law by summer (after “reconciliation” of the different but similar bills passed by the Senate and by the House of Representatives).  Federal regulation will be seriously tightened on commercial and investment banks and will be extended to non-bank financial institutions such as hedge funds and private equity groups -- as well as Too Big To Fail (TBTF) financial behemoths, derivatives, credit-rating agencies and insurance.

The rapid reform (of what is arguably the most important, and politically powerful, sector of the U.S. economy) is somewhat surprising as an outcome. A polarized Congress might have taken much longer to agree on key regulatory changes, especially because the finance industry had massively lobbied Senators and Congressmen. But voter anger at Wall Street carried the day. At the same time, law-makers declined to heed calls for some extreme measures liable to expose the Fed to political interference. That could have been damaging for long-term monetary and price stability. The outcome leaves the Fed in a comparable position to the European Central Bank’s independent status.

The rapidity of the reform owes much to President Obama’s success in March in energetically forcing through a major reform of health care – a political victory that energized Congressional proponents of financial reform. A strikingly large number of the changes proposed by the President proposed less than a year ago have been approved by the House and the Senate in separate but not too dissimilar bills. Developments in Congress were also influenced by a rash of cases that put Wall Street banks and firms under civil and criminal investigation for dubious practices alleged to have contributed to the financial crisis.

At this pace, the U.S. will move ahead of plans by the European Union and G-20 countries to reform their financial sectors. This could complicate international coordination of regulatory reform, an ambition aimed at reducing the risk of seeing financial players evade new constraints by going to less strict countries. Given the dominant role of U.S. financial markets and institutions, the imminent U.S. regulatory reform is likely to be the template for European and G-20 reforms – as described on this website.

Despite rearguard actions by lobbyists, key measures affecting the Federal Reserve seem clear: these include:

The overall change seems useful. The FSOC will have responsibility for systemic risk, but the Fed will be the principal active regulator and actually have its authority extended. Full implementation of the final bill’s measures will take years, but they will cause fundamental changes in the way U.S. finance functions.

Considering the breadth of these reforms of the U.S. banking and financial sectors, it is remarkable that the Fed’s independence has been so well safeguarded. On that crucial question, the U.S. and the EU seem set to remain in tandem.

 

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J. Paul Horne is an independent international market economist is based in Europe and the U.S. JPH12Econ@verizon.net