Resolving a crisis is good. Preventing one is better.
As financial markets start to get back on track, it is time to begin thinking about what we can do to forestall similar crises in the future.
We may not need more regulation of the global financial system, but we certainly need smarter regulation. The government must be able to determine where excessive financial risks are accumulating and limit them before something big blows up. The main question is whether a single regulator should be in charge, or whether responsibilities should be divided among multiple agencies.
In an article in the New York Times, economist Alan Blinder compared the two approaches to a family doctor and an HMO. Those who want multiple agencies to work in tandem in order to manage economic risks favor the family doctor plan. The doctor—the primary regulatory agency—examines the patient but, instead of carrying out treatments himself, merely refers the patient to the appropriate external specialist.
A family-doctor-style regulator might, as Blinder puts it, send ailing companies “to the Securities and Exchange Commission for securities problems, to the banking agencies for safety and soundness issues, and to someone for problems with derivatives—once we figure out whom that someone is.”
Under the HMO plan, one branch of a single agency assesses what risks are present and then alerts internal specialists who can immediately get to work on treating those risks.
The first approach, as Blinder suggests, has the potential to lead to a mess of turf wars and miscommunication, while the second offers the promise of smoothness and efficiency. There is plenty of evidence that fragmented, unaccountable regulation played a major role in the near-breakdown of the banking and credit systems last year.
A single agency would be able to address the big picture. This is important in the financial world because banking, investing, insurance and other financial activities do not function independently. They interact with one another in a complex web that can fall apart if a single strand breaks. No individual specialist, focusing exclusively on securities, banking, or derivatives issues, had the knowledge and power necessary to forecast and prevent last year’s crisis.
But which agency should be in charge? The Obama administration backs the Federal Reserve, and it is exactly right. The Fed’s political independence and overall responsibility for the economy make it the best suited for the job. These same factors also guarantee resistance from Congress, which already resents the Fed’s autonomy.
The Treasury plan to overhaul the nation’s regulatory structure would put the Fed well on the way to taking its place as the country’s financial HMO, both assessing and alleviating problems. Treasury Secretary Timothy Geithner spoke strongly in favor of the importance of concentrating power in a single agency, saying “At the core of making the system stronger is to give one place in the system clear accountability, responsibility and authority for preventing future crises.”
Next time, we can hope someone will hear that ominous ticking before the explosion.