Federal Reserve & Interest Rates

Another key figure from the Federal Reserve gave testimony this week before the Committee on Banking, Housing and Urban Affairs of the U.S. Senate.  Congress will be attempting to rework the nation’s financial regulatory structure in an effort to prevent a re-occurrence of the events that nearly lead to a collapse of the banking system.

Improved prudential supervision–the topic of today’s hearing–is a necessary component of the policy response. The crisis revealed supervisory shortcomings among all financial regulators, to be sure. But it also demonstrated that the framework for prudential supervision and regulation had not kept pace with changes in the structure, activities, and growing interrelationships of the financial sector. Accordingly, it is essential both to refocus the regulation and supervision of banking institutions under existing authorities and to augment those authorities in certain respects.

In my testimony today, I will begin by suggesting the elements of an effective framework for prudential supervision. Then I will review actions taken by the Federal Reserve within its existing statutory authorities to strengthen supervision of banks and bank holding companies in light of developments in the banking system and the lessons of the financial crisis. Finally, I will identify some gaps and weaknesses in the system of prudential supervision. One potential gap has already been addressed through the cooperative effort of federal and state banking agencies to prevent insured depository institutions from engaging in “regulatory arbitrage” through charter conversions. Others, however, will require congressional action.

This all comes at a time when markets are growing increasingly concerned over what direction the Fed will be heading, as current Chairman Ben Bernanke’s term is set to expire at the end of the year.  So far the Obama administration has been vague on whether or not Bernanke will or will not be re-confirmed as head of the Fed.

While he has received praise for his handling of the financial crisis from many circles, it can’t be overlooked that he was at the helm when the events leading up to the recession took place.  Although most of the criticism has been aimed at his predecessor Alan Greenspan, he does share some of the blame.

That being said many analysts expect the Fed’s regulatory powers to grow after the regulatory shake up that is coming.  It will likely gain broad powers in order control systemic risks.  Many business are also wondering how heavy handed the government will be after the paint dries.

The government has pretty much took a hands off approach since the 1980’s, but now with so many tax dollars at risk, that will no longer be the case.  Along with increased supervision of the banking system, Congress will also take a look at reigning in rampant speculation in the commodities market, as well as trying to figure out how to get a handle on derivatives markets and credit default swaps.

Most of the changes won’t happen overnight and business should have an opportunity to peruse the new regulatory landscape before they map out plans to deal with it.  Hopefully Congress will be able to find the right balance between a stifling regulatory structure and one that has the proper controls in place to prevent another financial meltdown.