Devil is in the Details

This week the U.S. Senate Committee on Homeland Security and Governmental Affairs conducted a hearing on how systemic risk needs to be governed by our financial regulatory agencies.  All agreed for the need of a single regulator, but there was not unanimous agreement on who should serve in the role.  Most point to the Federal Reserve given their role as the lender of last resort.  However, a few fear the increased level of political influence on the Federal Reserve given that they are the central bank for the United States.   Here is the view of Robert Pozen, Chairman of MFS Investment Management and Senior Lecturer at Harvard University.

1. The United States needs one federal agency to play the role of systemic risk regulator because of the increasing frequency of global financial crises and higher correlations among different investment markets.

2. Congress should give this role to the Federal Reserve Board because it has the job of bailing out financial institutions whose failure would threaten the whole financial system.

3. The Federal Reserve Board should focus on five areas that are likely potential sources of systemic risk – inflated prices of real estate, institutions with high levels of leverage, new products falling into regulatory gaps, rapid growth in an asset class or intermediary and mismatches of assets and liabilities.

4. The Federal Reserve Board should monitor closely the activities of all types of financial institutions with very large or otherwise very risky assets since they are the ones most likely to impact the whole financial system.

5. If the Federal Reserve believes that actions need to be taken to reduce systemic risks, it should work closely with the regulatory agency with primary jurisdiction over the relevant institution, product or market.

Senator Joe Lieberman, chairman of the committee holding the hearing, said lawmakers have a large task in redesigning financial regulation, which is now broken. "We cannot expect the creation of a systemic risk regulator to be a universal remedy for all that ails our financial services industry today," Lieberman said. "As always, the devil is in the details."