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Time to Reform the Fed

Conflict arises over its roles as regulator and lender of last resort

By Christopher Whalen. Christopher Whalen is a writer and consultant based in Washington. / January 20, 1994



TREASURY Secretary Lloyd Bentsen has proposed legislation consolidating bank regulation functions into a single new national banking commission, which would take over the day-to-day responsibilities now shared by the Treasury's Office of the Comptroller of the Currency, Federal Deposit Insurance Corporation (FDIC), Office of Thrift Supervision (OTS), and the Federal Reserve Board.

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Under Mr. Bentsen's proposal, the new commission would examine banks and set legal standards for mergers and new financial services, products, and activities. Representatives of the Fed, the OTS, and the FDIC would sit on the commission's new advisory board, giving each agency access to confidential financial data and the opportunity to express its views as part of the overall regulatory process.

Most members of Congress and officials of the various banking agencies agree that regulatory consolidation is badly needed. Only the Fed's entrenched Washington bureaucracy resists change, even though reform would ultimately benefit the nation's financial system. The Fed is determined to fight the Clinton administration and members of Congress, such as House Banking Committee Chairman Henry B. Gonzalez (D) of Texas, who support a unified banking agency.

Since Bentsen made his proposal, the Fed has begun a covert lobbying and disinformation campaign to block the reform effort. Former Fed Chairman Paul Volcker, among others, has begun to warn of terrible consequences if the Fed is taken out of the business of supervising banks. The Fed even managed to recruit unlikely allies in the corporate community to run Op-Ed articles supporting a ``hands off'' posture for Congress regarding the Fed. It is some measure of the tangled state of affairs in Washington that congressionally chartered agencies such as the Fed can spend tax money to defend their bureaucratic turf against the wishes of elected officials.

Despite the Fed's protestations, there are a number of sensible arguments for getting the central bank out of the business of supervising banks. Foremost is the conflict of interest between the Fed's role as regulator and as lender of last resort. Events of the past decade show that it is suspect financially and dangerous politically for the agency that determines the solvency of a federally insured bank to be in a position to make loans to that institution.

With the FDIC Improvement Act of 1991, Congress sought to curb Fed discount window loans and other expedients used to keep insolvent banks afloat. During hearings on this important legislation, members of Congress criticized senior Fed officials in Washington for ``playing God,'' in the words of Mr. Gonzalez, by keeping such banks open through a combination of secret loans and forbearance on supervisory requirements.

Congress never empowered the Fed to bail out private banks, based on a concept known in financial markets as ``too big to fail.'' The morally suspect practice of propping up banks has cost taxpayers billions of dollars in losses to the FDIC, while rewarding bad management practices at certain large institutions.