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Federal Reserve Bank’s Additional Powers – Weekly Round-Up

This past week, talks in Washington centered on regulating the financial industry. The Obama administration has proposed to give the Fed systematic powers in overseeing the banking sector as a whole. A lot of lawmakers are criticizing this plan, arguing that giving too much power to the Fed might be risky. There is currently limited disclosure about the Fed’s multibillion-dollar lending programs. If they weren’t transparent in the past, why would they change in the future? Another concern is the structure of the Federal Reserve itself. Regional branches are not classified as government agencies.

Meanwhile, other lawmakers cite that the Fed has a conflict of interest. If it tasked to conduct monetary policy then it might not be the best body to supervise banks. Senior Fed officials have argued, however, that the two tasks are actually complementary. Since the agency is involved in crisis stabilization, they need to have other roles in the financial system.

Whatever the case may be, ultimately, it is the public who has to pay for the decisions made on Capitol Hill. Bloggers from all over the country have expressed their opinions about these developments. Here is a list of blogs that talk about the Fed’s proposed systematic role, the criticisms of the system, and how it will affect ordinary Americans:

Paul Joseph @ Prison Planet wrote an insightful blog post entitled “Ron Paul Slams Federal Reserve’s New Dictatorial Powers“. Here, he provides a lot of quotes from Ron Paul and explains his argument. The criticism of Obama’s proposal is centered on giving the Fed additional authority. It might be too risky for the industry as a whole.

The Look at Vietnam blog provides updated information about the news in Capitol Hill. One article uploaded this week is titled “Geithner Says Federal Reserve Best Positioned for Super Regulatory Role“. It explained the position of the Treasury Secretary. He also said that the plan will only give the Fed a modest amount of additional powers.

Sudeep @ the Wall Street Blog wrote an in-depth blog post, “Financial Regulation: Congress Takes on the Federal Reserve“. It basically outlines the arguments lawmakers have over Obama’s proposed reform and the administrations answer to these concerns.

Fed Tasked to Oversee Systematic Risks in the Financial Industry

The Federal Reserve took a lot of flak from lawmakers when it failed in its oversight responsibilities and the financial crisis occurred. Now, it seems that the Obama administration is planning to remedy this situation by endowing the agency with the authority to oversee systematic risk. If this plan passes Congress, it will usher in the Fed’s biggest reform in decades. At the same time, the Federal Reserve’s emergency lending capabilities will be limited.

The proposed financial regulation will require the central bank to get written consent from the Treasury before it can give emergency bailout funds. In addition, Obama wants a comprehensive review on how the agency regulates financial companies. In essence, the move is a proposal that aims to prevent regulatory loopholes that result to risk build-up. However, a significant part of the plan requires the approval of Congress where ideological clashes will likely occur. Despite this, the president wants to sign the bill at the end of this year.

New Fed Oversight Responsibilities

Everything from mortgage lending practices to investment strategies will be affected in the government’s across-the-board effort to stop reckless decision-making that helped spark the economic crisis. According to Obama, “we have to have somebody who is responsible for seeing the risk of the system as whole and not just individual institutions.” He added that the “Fed is best positioned to do that”.

Essentially, the plan will overhaul the outdated financial system and make way for fundamental changes. Instead of using a “bulldozer” to clear the path to reforms, senior government officials likened the reforms as restructuring an existing system. It can be likened to an architect’s blueprint for improving an old structure.

Obama’s 85-page white paper outlines the reason why the economic crisis occurred and gave proposals on how these loopholes can be plugged. Among the most notable reasons include the yawning gaps in regulation that allowed banks to lend to borrowers that cannot afford it. Funding these loans can from exotic investments that regulators poorly understood. In addition, problems with executive compensation were also tackled.

Fed Ties to Banks Incite Calls for Change

It recently came out that the directors of 12 regional Federal Reserve Banks have ties with privately held financial institutions and banks. They are either board members or have significant shares in these institutions. This revelation has incited calls to overhaul the policies of the banking establishments as a whole. On Monday, the Wall Street Journal outlined how Stephen Friedman, a Goldman Sachs Group director and the chairman of the New York Federal Reserve, was allowed to hold both positions even after Goldman Sachs became a Fed-regulated bank last September.

Following the revelation, the New York Federal Reserve has faced a lot of criticisms on its corporate-governance practices. Other regional Federal Reserve Banks including those from Dallas and Kansas City had said they wouldn’t have permitted this type of situation to occur.

According to Cam Fine, the chief executive of the Independent Community Bankers in America, no regional Federal Reserve director should be allowed to have connections with a regulated financial establishment. He added that this “should be a very bright line”. The New York Fed is particularly important because a number of the nation’s largest financial institutions are found in New York.

When the Federal Reserve was formed in 1913 by Congress, it required the 12 regional banks to have nine board members. Three will be appointed by the Fed Board in Washington while six will be elected by the local banks. The regional banks are tasked to give recommendations about the Fed’s discount rate and other matters to the Washington office.

Under its rules, three Class C directors, such as Stephen Friedman cannot hold positions at banks that are regulated by the Federal Reserve. But lawyers sought a way around by asking for a waiver of the Fed policy. This allowed Mr. Friedman to continue his role as Fed chairman even as he held on to a large Goldman Sachs stock at the same time.

The Minneapolis Federal Reserve chairman also asked for a similar waiver. John Marvin, the chairman there, holds shares on both Morgan Stanley and Goldman Sachs. There is good news though. Other regional Fed banks have announced they wouldn’t permit such maneuvers. The Dallas Federal Reserve Bank has asked chief executive Myron Ullman to resign from his Pzena Investment Management position before he was allowed into the Fed board.

Washington Fed officials are responding to the call for more transparency. On Tuesday, Ben Bernanke has announced that more details will be revealed about its borrowers. Currently, it is also reviewing the rules for its regional bank directors in the hope that conflicts can be avoided in the future.

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