Much has been made of the proposed increase in Federal Reserve power to discharge the role of systemic risk regulator. Senators don't particularly like it and commentators such as Elliot Spitzer and Dean Baker have offered that the real problem is that existing authority, which was sufficient, was not used.
Perhaps a compromise is in order.
The Financial Services Oversight Council could discharge much of the initial work of a systemic risk regulator by collecting data, analyzing it for emerging systemic risk and then referring a matter to the appropriate agency.
Oh, wait, that's already in the proposed White Paper.
What type of information would the FSOC find material to its charge of assessing emerging systemic risk?
Two types come to mind immediately. Scott Patterson in the WSJ yesterday mentioned that excessive leverage was a problem in the crisis. No argument there. It follows then that the FSOC should collect all available information related to employment of leverage by financial entities consistent with its duties.
Secondly, the history of Bear Stearns and AIG indicate that interconnectedness can result in substantial systemic risk. The FSOC should be collecting all information regarding counterparty risk to assess whether an unhealthy concentration is developing in the system. Perhaps a hedge fund is counterparty to an excessive number of contracts such that it could not pay in a black swan event. Perhaps the proprietary trading by a bank employs too much internal and external leverage. The amount of information to be gathered and analyzed could be substantial.
Leverage and counterparty risk -- two very important pieces of information for any systemic risk regulator to store in its database.
Given the importance of the FSOC in this regulatory machinery, it might be wise to have a director appointed and confirmed with a ten-year term similar to an FBI director. That would permit the FSOC to be somewhat independent of political pressure and lobbying, but also leave it within Treasury, similar to how the FBI is part of the Department of Justice.
Just a thought.
