The Watchdog Needs a Watchdog

Commentary by SIMON JOHNSON


Two years after passage of the Dodd-Frank financial reform law, how are we doing putting in place crucial provisions, including a way to control systemic risk? Not well, according to Sheila Bair, chairman of the Federal Deposit Insurance Corp. during the 2008-to-2009 economic disaster and author of some of the reforms in the act.

Dodd-Frank created the all-important Financial Stability Oversight Council, which replaced the President’s Working Group on Financial Markets. The working group had lacked authority to coordinate the alphabet soup of regulators overseeing the U.S. financial system.

The intent for creating this council was clear: It would take charge of financial stability, put the Treasury secretary in the chair and empower a new Office of Financial Research within the Treasury to collect and analyze data on the financial system.

None of this organizational structure has worked well in practice. “FSOC is MIA,” Bair told the New York Times in June. “OFR is barely functional.” The result: “The public is becoming cynical about whether the regulators can do anything right.”

Why the council has been so ineffective is murky. Is it lack of enthusiasm on the part of Treasury, opposition from other regulators or opposition by large banks? The people who run the big banks don’t want to be pushed to become safer; they like a payoff structure in which they get the upside when things go well and the downside risk is someone else’s problem.

It surely helps government officials to have a well-informed, articulate group of outsiders pushing them from the other direction. That’s why Bair on June 6 established a private-sector systemic-risk council, an initiative funded by the Pew Charitable Trusts and the Chartered Financial Analysts Institute. (It includes representatives of both political parties, business leaders and academics like me. Though I’m a member of this committee, I’m writing here in my personal capacity.)

Putting pressure on officials to implement Dodd-Frank should be relatively straightforward. The council can use polite yet persistent pressure.

A more difficult task is to measure and comprehend system risks before they become debilitating. That’s what the Office of Financial Research is supposed to do. It should coordinate the release of timely information from all parts of the financial system. For example, how should we measure the current exposure of our financial system to the sovereign-debt and banking crisis in Europe? What’s the right way to think about the potential losses that could be incurred through the derivative positions of very large banks?

Our ability to ensure financial stability is only as good as the available data. I’m concerned that when the next financial crisis hits, the OFR will be the weakest official link.

SIMON JOHNSON IS A COLUMNIST FOR BLOOMBERG VIEW IN WASHINGTON. THE OPINIONS EXPRESSED ARE HIS OWN. This email address is being protected from spambots. You need JavaScript enabled to view it.


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