Why is Congress Trying to Expand the Fed?

The Federal Reserve — already one of the most powerful and least accountable entities in the federal government — is about to become even more powerful.

It’s all part of a scheme to rewrite the nation’s financial laws and allow banks, securities firms, insurance companies, and, in some cases, industrial firms to merge under common ownership in giant conglomerates. Under the plan, now being considered in Congress, the Federal Reserve would become king of the hill among the federal financial regulatory agencies. It would, in effect, become the regulatory body, with the Federal Deposit Insurance Corporation, the Office of Thrift Supervision, and the Office of the Comptroller of the Currency taking a backseat on critical issues involving the safety and soundness of the financial system.

This legislation raises a big question about just how well the present members of the House and Senate Banking Committees truly understand how far the Fed operates outside the rules that govern the conduct of the rest of the government.

Ironically, the proponents of the new financial legislation, H.R. 10, are promoting their plans by insisting that we need to change depression-era laws — as if the mere date of these laws and statutes were sufficient rationale for their wholesale eradication.

If H.R. 10’s proponents are worried about these outdated laws, they might take a look at one that’s older still — the Federal Reserve Act of 1913. It is doubtful that such a law, riddled with conflicts of interest and absent of accountability, would be taken seriously today as a proper framework for a federal regulatory agency in a democratic government.

Enacted in 1913, the Federal Reserve Act allows commercial banks to select two-thirds of the board of directors for each of the 12 Federal Reserve Banks. As a result, these boards are populated not only with bankers but also with representatives of securities firms and insurance companies, all of which will come under some degree of Federal Reserve jurisdiction if H.R. 10 becomes law.

Each of the 12 Federal Reserve Banks — operating under the guidance of these bank-controlled boards — supervise and police those holding companies and state banks that are members of the Federal Reserve. Tough regulatory decisions that protect the safety of financial institutions and taxpayer-supported deposit insurance funds do not always coincide with a central bank’s concept of what promotes its economic policy at any given moment. It is difficult to imagine a clearer picture of conflicts of interest.

When the Long-Term Capital Management hedge fund collapsed last fall, the problems with the Federal Reserve board became all too apparent. The Federal Reserve — led by chair Alan Greenspan and William McDonough, president of the New York Federal Reserve Bank — engineered a $3.5 billion corporate bailout of the hedge fund, claiming that the stock market was in danger of a meltdown. In the process, the Federal Reserve used its regulatory power to lean on three big commercial banks under its day-to-day supervision — Bankers Trust, J. P. Morgan, and Chase — to put up $300 million each for the bailout.

It doesn’t take much analysis to realize what was really going on here. In an op-ed article in the Washington Post, Jim Leach, chair of the House Banking Committee, wrote:

“… it is difficult not to be struck by the fact that the shrewdest in the hedge fund industry could commit such investment errors; that the most sophisticated in banking would give a blank check to others in an industry which they are also considered to be experts; and that the U.S. regulatory system could be so uncoordinated and so easily caught off guard.”

Such conflicts of interest between monetary policy and bank regulatory policy are why many nations separate the two functions. Some of these nations are Great Britain, Austria, Belgium, Canada, Denmark, Finland, Germany, Japan, Mexico, Norway, Sweden, and Switzerland.

The Federal Reserve certainly doesn’t have an untarnished record as a banking regulator. The General Accounting Office raised a number of questions about the Federal Reserve’s performance, noting a lack of minimum inspection standards that led to superficial approaches to inspections of bank holding companies.

Now Congress is planning to pile huge new duties and powers on the Federal Reserve. If the Fed’s inspection standards have been lax under its present responsibilities, one can only imagine what will fall between the cracks if it’s allowed to supervise the trillion-dollar conglomerates created under H.R. 10.