Today the Financial Times has a comment penned by Morgan Stanley’s Asia chief Stephen Roach, “Add ‘financial stability’ to the Fed’s mandate.”
A regulatory backlash is under way as the US body politic comes to grips with the financial crisis. Wall Street – or what is left of it – is first in the line of fire. But the era of excess was as much about policy blunders and regulatory negligence as about mistakes by financial institutions. As Washington creates a new system, it must also redefine the role of the Federal Reserve.
Specifically, the US Congress needs to alter the Fed’s policy mandate to include an explicit reference to financial stability. The addition of those two words would force the Fed not only to aim at tempering the damage from asset bubbles but also to use its regulatory authority to promote sounder risk management practices….
By adding “financial stability” to the Fed’s policy mandate, I am mindful of the pitfalls of multiple policy targets. However, single-dimensional policy targeting does not cut it in a complex world…
But hindsight offers little doubt of the bubbles that developed over the past decade – equities, residential property, credit and other risky assets. The Fed wrongly dismissed these developments, harbouring the illusion it could clean up any mess later. Today’s problems are a repudiation of that approach.
Roach seems blissfully unaware that the Fed has already assigned itself the duty of achieving financial stability without any Congressional authorization. From the central bank’s website:
The Federal Reserve System is the central bank of the United States. It was founded by Congress in 1913 to provide the nation with a safer, more flexible, and more stable monetary and financial system. Over the years, its role in banking and the economy has expanded.
Today, the Federal Reserve’s duties fall into four general areas:
conducting the nation’s monetary policy by influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates
supervising and regulating banking institutions to ensure the safety and soundness of the nation’s banking and financial system and to protect the credit rights of consumers
maintaining the stability of the financial system and containing systemic risk that may arise in financial markets
providing financial services to depository institutions, the U.S. government, and foreign official institutions, including playing a major role in operating the nation’s payments system
We took umbrage earlier that the Fed was engaging in mission creep, assigning itself duties not authorized by Congress: In a post dated August 22:
The Fed even considers itself to be in charge of the stability of the financial system , even though Congress has not added that to its job description.
Readers can find a sampling of other discussions on this very topic in “Robert Shiller Pushes Fed as Stability Regulator” (April), “Waldman: Halt the Fed’s Mission Creep” (May). We have been decidedly cool on the idea, largely because the Fed has put the “financial stability” under its list of duties since at least 2003 (that was the date assigned to the first version of that statement that we saw at the Fed’s website), and the Fed certainly did not comport itself well in recognizing, let alone intervening in, explosive, destabilizing credit growth in recent years.
Evidence for Greenspan’s presentations to Congress in the dot-com bust expressed concern that the fall in stock prices could have a detrimental impact on growth due to a fall in consumer wealth. This was the first time any Fed chairman had even formally taken the view that the level of stock prices was part of his job, although the Wall Street Journal had earlier reported on the Fed chairs’ obsession with the stock market. Thus, the famed Greenspan put, the Feds’ famed quick trigger response to falls in stock prices, was in fact based on a misguided view that this was in fact pro-stability.
In other words, I see little reason to give a regulator responsibility for a role it assigned itself and botched horribly.