Against a "Systemic Risk Council"

Sheila Bair has publicly opposed the creation of a single systemic risk regulator, and has instead been pushing for a "systemic risk council" that would include the Treasury, the Fed, the SEC, and (surprise!) the FDIC.

This is a bad idea. The primary benefit of a single systemic risk regulator is its ability to see how the different areas of the financial markets interact with each other. The financial regulatory structure in the U.S. is famously balkanized, with the SEC, CFTC, OCC, OTS, FDIC, and the Fed each focusing on its own little slice of the financial markets. The regulators don't necessarily have the ability to see how developments in one area of the financial markets affect another, separately regulated, area of the financial markets. And even if they do see how developments in their sphere are affecting (or being affected by) other areas of the financial markets, the only thing regulators care about is making sure the losses fall outside their own sphere. For instance, when a thrift that's owned by a large financial holding company is holding risky assets, OTS often forces management at the holding company to shift the assets from the thrift's books to the parents'. Problem solved!

A "systemic risk council" would do a poor job of monitoring risks across different areas of the financial markets. Each regulator would come to the council's meetings and, like always, report that his agency's area of the market is just fine (whether it's true or not, as no regulator will admit that his agency has been doing a poor job of supervising its area). Then they'd all congratulate each other on doing such a damn fine job. Meeting adjourned.

Also, it's important to note that we've already tried Bair's approach to some extent. After Black Monday in 1987, we created the President's Working Group on Financial Markets (PWG), a committee of financial market regulators that broadly deals with systemic risks. You can see how well that's worked out. To take my favorite example, the PWG started working on a report on market instability after the two Bear Stearns hedge funds collapsed in August 2007, which was the opening salvo of the credit crisis. The PWG finally released its report on March 13, 2008, which was the day that Bear Stearns officially collapsed, and one the most frightening days of the entire financial crisis.

(Incidentally, the FDIC isn't a member of the PWG. The group includes the Treasury, the Fed, the SEC, and the CFTC, and has informally included the OCC and the New York Fed during the current financial crisis. Conveniently, Bair's systemic risk council would finally place the FDIC at the adults' table, and would relegate the CFTC and the OCC to the kids' table.)