Fixing the Fed

Christopher Dodd, D-CN and chair of the Senate banking committee, introduced a 1,136 page plan to overhaul regulations for banks and other financial institutions. There are many obviously needed new regulations proposed in the bill (control of derivatives, consumer protections, controlling systemic risk, etc.) but what caught my attention was the provision that takes banking regulation away from the Federal Reserve. This step should be thought about very carefully and I haven't seen any blog traffic but expect to see a lot of discussion soon.

The mission of the Federal Reserve has changed over time (read the history here), but one of the original founding objectives was control of the money supply. The US Treasury controls how much money is printed but the banks control the extension of credit (effectively creating money) and the Federal Reserve controls bank reserves (the source of credit). On the one hand, the Fed needs a very good understanding and control over what banks are doing if it wants to control the money supply. On the other hand, the Fed is just another bank, the central bank. Since it operates independently, it begs the question of "who regulates the regulator"? I guess this is the point of Ron Paul's, R-TX, bill and book ("End the Fed").

We seem to be at an historical conjuncture where the Fed is loosing political support for its mission. It would be useful, before acting, to reflect on the financial history of the late 20th century, re-read Hyman Minsky's "Stabilizing an Unstable Economy" and have a very open public discussion about financial regulation and the role of the Federal Reserve. It would also be useful to think about how fast we want the US economy to grow and how much of the growth should be the result of financial manipulation. Slower growth and less financial manipulation would lead to fewer housing and stock market bubbles and lower CO2 emissions. Unfortunately, politicians are hooked on growth and they will ultimately decide the fate of the Fed.