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central banks redux?

 How different now looks the world of financial supervision from the way it looked a few short months ago.  The Fed is emerging from the congressional financial reform <a href="professional.wsj.com/article/SB100014240...;>process</a> stronger than ever before.  It will not only retain its supervisory authority over the large number of state chartered member banks but will become the all-important regulator of larger financial holding companies including thrifts, and others deemed “systemically important.”  The Fed might even retain umbrella authority over consumer protection.  In Britain a similar drama is <a href="www.telegraph.co.uk/finance/comment/rich...;>playing out</a>.  The new coalition government has announced that the powers and functions of the Financial Services Authority (NYSEARCA:FSA) will be returned to the Bank of England where they will be discharged as a division of the Bank.

 
A decade ago, in halcyon days of deregulatory prosperity, the role of central banks seemed so obvious:  they existed to manage monetary policy, no more, no less.  Furthermore they seemed really good at this, so their independence from political influence became the model for the world.  New supervisory agencies were created to separate bank regulation from monetary policy.  In the US both the Bush and Obama Treasury Departments urged consideration of new regulatory models from abroad, such as the FSA in Britain, whose functions had been transferred from the Bank of England, and the Australian Prudential Regulation Authority (APRA), itself also separate from the Australian central bank.
 
Then the financial crisis happened.  We discovered that central banks really do still matter and in ways that reach well beyond monetary policy.  Without massive action by the Fed in the USA and Bank of England in the UK, all would have been lost.  Of course other agencies and departments pitched in, most notably the Treasury in the US and Chancellor of the Exchequer in the UK, but none of the regulatory agencies possessed enough capacity to save the situation by themselves.  
 
There has of course been enough blame to go around.  The FSA was asleep at the switch when Northern Rock collapsed.  The Office of Thrift Supervision (OTS) dropped the ball in the case of AIG (though it is fair to say that almost every financial agency had a hand in that debacle).  The Fed itself made its own share of egregious mistakes.  So everyone hated the Fed and Chairman Ben Bernanke darn nearly never got reconfirmed.  For a while it even looked like the Fed might be dismantled or at least lose almost all its regulatory powers.
 
So what is going on?  First, most of the anger was directed at the Fed precisely because the Fed is where the action lies when things really matter.  Like it or not, the Fed Chairman and the various presidents of the Federal Reserve Banks have proven to be the official thought leaders (admittedly with conflicting views) on how to change the system.  We have also discovered that monetary policy and bank regulation can’t be separated when the going really gets rough.  While we have learned the importance of systemic risk (or “macro prudential”) regulation, and even talked about having separate systemic risk regulators, the reality is that the connections between macro- and micro-prudential regulation are deep and often inseparable.  There was more merit than many would admit to the Fed’s seemingly self-serving protest that it needed hands-on supervisory authority.
 
It is only powerful central banks that have the resources and capacity to match the mammoth financial organizations we have allowed to proliferate across the globe.  The US reforms, unlike the British ones, are messy and leave the landscape in considerable disarray, so it will be incumbent on Mr. Bernanke and the governors of the Fed to display the kind of independent leadership and resolve that is necessary to rebuild American financial regulation.  But this aspect of the reforms are not only headed in the right direction; they are also probably inevitable.


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