Senate Banking Committee Chairman Christopher J. Dodd, D-Conn., insists the ambitious draft financial regulation bill that he unveiled is not about Fed-bashing. Yes, it would transfer the Fed's consumer protection functions to a new agency. And true, whereas House Financial Services Committee Chairman Barney Frank, D-Mass., would put the Fed in charge of "systemically important" financial firms, Mr. Dodd would create a board on which the Fed is merely represented. But the goal, Mr. Dodd says, is to enhance Fed independence by allowing it "to get back to its core enterprise."
He has a point. The key to a central bank's power is credibility, which in turn hinges on the perception and reality that it is focused on setting interest rates and not doing the short-term bidding of politicians. Under Paul A. Volcker, the Fed broke the back of inflation in the 1980s through sustained high interest rates. This put the country in recession and made the Fed unpopular. It could withstand the pressure because it was so clearly acting within its core technical and legal competencies. A lesson of the current crisis, by contrast, is that mission creep is not good for political independence. The more the Fed becomes enmeshed in lending to particular companies or regulating particular industries, the more it opens itself up to criticism and lobbying.
In that sense, it might be a good idea to assign the Fed's regulatory responsibilities elsewhere as Mr. Dodd proposes. In other respects, however, Mr. Dodd's bill seems to increase the Fed's politicization. The draft bill would also narrow the Fed's powers to make loans in a crisis and subject any loans it did make to detailed oversight by Congress. This is intended, apparently, to address situations such as the Fed's bailout of AIG. The wisdom of limiting the Fed's "lender of last resort" powers depends largely on the efficacy of the alternative resolution authority that Congress and the administration are developing to deal with "too big to fail" institutions.
- Washington Post
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