Systemic Risk Council

By Jeff Harding

Another “you read it here first.”

Senator John Warner criticized the Obama Administration’s grant of power to the Fed to regulate financial risk, saying that would put too much power in the hands of one institution. Instead he proposes a Systemic Risk Council to regulate economic risk:

He proposed, based on consultation with outside experts, creating a Systemic Risk Council that would avoid “entrusting systemic risk responsibility with one agency that has other missions that can be a source of conflict.” Under his proposal, the council would include the Treasury secretary, Fed chairman and heads of major financial regulatory agencies. The group would monitor systemic risks and have authority to act in a narrow set of areas.

I wrote about this back in August, 2008, predicting that the government would try to regulate economic risk (“President Obama Appoints Nobel Laureate McFadden to Head New Financial Risk Commission“). I guessed, wrongly, that Professor McFadden would be the head of the council.  Then I wrote:

The commission he advocates would hire hundreds of financial experts, economists, and bureaucrats to review financial products. Commercial bankers and investment banking houses would have to run products by the commission for approval. They would have the burden to show that their offering or financial structures would do no harm based on rules and regulations established by the commission. There would be lawyers specializing in getting products through the commission. There would be administrative judges and appeals to federal courts. CCH and WestLaw would publish volumes of rules and regulations, decisions, and letters.

The fact that a commission will make economic decisions about financial products rather than the market is frightening and threatening. …

Could this commission staffed by intelligent bureaucrats have foreseen the explosive growth of asset-backed securities, the proliferation of products, the impact of loose money, the subsequent dramatic rise of home prices, the frenzy of speculation, and the subsequent collapse? No. To suggest that it could be done is rather naïve and dangerous thinking.

McFadden, like many of his econometrician brethren, apparently thinks he is able to create a perfect mathematical model of human economic behavior. Tweak a bit here, a bit there, and you have a perfectly functioning economy. It’s just too messy to be left to us to make our own decisions (i.e., the free market). The econometricians, he believes, are smart enough and capable of making economic decisions for us that will smooth out the business cycle.

I suggested that this council would have a dampening impact on financial innovation:

Can you imagine Professor McFadden’s financial risk commission at the birth of Wall Street? They would have argued, correctly, that stocks are too volatile and market booms and busts present too great of a risk for the economy. Only bonds would be suitable to keep the economy stable. They would, of course, ignore the benefits of raising capital for enterprise and the dynamic American economy would have never gotten off of the ground. They will stifle innovation and economic growth because their mandate is to prevent disruption to the economic risk council, not to promote growth.

It would be nice if the Republicans would at least talk like they believed in free markets once in a while.