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Why Is the Fed Chairman a Bank Regulator (or an Economist)?

posted by Adam Levitin

The NY Times has a pretty significant error in its reporting on the Summers vs. Yellen Fed Chair race. It says that Yellen was the head of the Federal Reserve Bank of San Francisco, which was Countrywide's regulator. That's wrong. FRBSF was never Countrywide's primary regulator. That was the OCC and then OTS. The regional Feds are not anyone's primary regulator, not least as they are private entities, not government agencies. They arguably have a secondary quasi-regulatory role, but that's it. They are not the same as the Board of Governors of the Federal Reserve System, which is a federal regulator. Yellen really can't be tagged with any of the blame for Countrywide, at least based on what's reported. The NYT should correct this point, which comes off as a bit of a smear on Yellen.

That said, the article seems to inadvertently underscore two critical issues that are not being discussed at all. First, why do we have a single job (Fed Chairman) that merges monetary policy (chairing the Fed's open markets committee) and bank regulation (chairing the Board of Governors)? There is a historical answer to this, as monetary policy used to be much more closely related to bank regulation, and bank regulation also used to be a much simpler affair, primarily because banks were simpler. But it seems strange today to have the Fed as one of four federal prudential regulators (OCC, FDIC, NCUA, Fed), and as the regulator for bank holding companies AND in charge of monetary policy. There's a good case that Dodd-Frank should have stripped the Fed of all quotidian bank regulation responsibility and left it with monetary policy and as a lender of last resort.

The second issue is why is the list of Fed Chair candidates inevitably just a bunch of economists given that bank regulation is arguably now the more important of the Fed's dual roles? (Actually treble, as the Fed also acts as an important payment system operator.). Why on earth would anyone think economists, no matter how brilliant, would be the go-to group for bank regulators? Economics studies the supply and demand of lots of things, including money, but that's quite different from bank regulation. Bank regulation simply isn't part of the typical economist toolkit. There are some economists who know a lot about bank regulation, but there are also some non-economists who know as much, if not more. (To name a few, Fed governors Dan Tarullo or Sarah Raskin Bloom or former FDIC chair Sheila Bair, all, I believe, lawyers by training, but also with bank reg experience as an academic, a state bank regulator, or a Congressional staffer.)

To be sure, we don't always demand real expertise of other regulatory heads--Mary Jo White isn't a securities expert, for example--in part because we recognize that the head of some agencies, even independent agencies, are political appointments, but the Fed has always tried to maintain an aura of being technocratic and apolitical. Indeed, it almost has to because its raisin d'être and authority stems from its claim to technocratic neutrality. Otherwise we'd just be back to monetary policy in presidential politics and Cross of Gold speeches. But perhaps it's time that we take the technocracy claim seriously and appoint someone with the technocratic bank regulation chops, rather than an economist. Or if we can't do that, then split up the monetary policy and bank regulation posts. Let the economists tend to monetary policy and regulatory experts tend to the banks.


Hold on, you want Dodd-Frank to strip the Fed of its bank regulation responsibility, and then in the very next paragraph you say that bank regulation is the most important role of the Fed? Which is it? Do you want the Fed to be a regulator or not?

Regardless, the Fed Chairman spends far more time and effort on monetary policy than on bank regulation, so having the Chairman be an economist makes sense. It's unreasonable to expect someone without "real expertise" to head the FOMC meetings and make speeches about monetary policy. I don't think they have to necessarily be an academic (e.g. Greenspan), but they'd better have a very solid grasp of macroeconomics.

Finally, you ask why economists would be the go-to group for bank regulators, but you failed to name an alternative group that has a better toolkit suited for bank regulation, or even outline what you would like to see in such a toolkit. If I were looking for a bank regulator, I'd want someone who is very good with capital structure, probability and risk, agency theory, monetary policy, banking markets, and banking law. Can you name a group that in general fits the bill better than economists? I can't. Of course, that doesn't mean that all bank regulators have to be economists--you named 3 people who would do quite well, I'm sure--but as a whole having economists be bank regulators seems to make a lot of sense to me.


1. My instinct is to split the regulatory and monetary policy roles, but if they are to be united, then I'm not sure that the monetary role should dominate in terms of looking for qualifications.

2. Yes, an economist makes sense for the monetary policy role.

3. There isn't a one-size-fits-all background. I would want someone who has some expertise with institutional structure and behavior and knowledge of markets. Some legal expertise would be good to--regulation is first and foremost a legal matter. The capital structure, monetary policy, agency theory issues don't strike me as critical (and capital structure just isn't that complicated).

Countrywide wasn't regulated by anybody. Nor was it subject to the Community Re-Investment Act
since it was not a bank.

The monetary policy function should be headed up by an actual banker, who knows what banks are doing, where and how much they are lending, etc. Any structure that stops the interest rate setting function from close contact with banks is doomed to failure as the BoE will tell you. Neither economist nor regulator is the prime skill for monetary policy, it is a banking function. Regulation in my view should be handled by a different agency, but understanding that there needs to be constant communication between both sides. The UK experiment of splitting the 2 roles led to huge bureaucratic upset, with the BoE apparently cut off from direct contact with banks, which they hugely resented. Geithner appears to have been critical of the BoE about LIBOR without realised that that issue was none of the BoE's business, so they did nothing. Pedantic and destructive, but bureaucratically correct.

Dryly 41: Countrywide Bank (primary subsidiary of Countrywide Financial Corporation) was an OCC-regulated bank through mid-2007, when it converted to an OTS-regulated thrift. Before and after the conversion, it was subject to the CRA. These facts can be verified with a quick web search. Cheers.


Thanks for the follow-up comments. One more quick item:

I agree with you that splitting the regulatory and monetary policy roles could make sense, and now I see where you're coming from there. In addition (or maybe even more importantly??), it seems like simplifying the regulatory environment would be desirable. The fact that we have the OCC, OTS, Fed, NCUA, DOJ (for antitrust issues), SEC, and FDIC all playing regulatory roles in depository institutions is just ridiculous.

And, just for the record, I would argue that capital structure, particularly for banks, can be extremely complicated. But that's probably a discussion for another day.

This is no kind of surprise. One of our lunch-time entertainments in law school was to spot the egregious errors of law in the legal articles in the NYT, even though the two principal, legal reporters were members of the New York bar. There was at least one in every article. With a steady stream of misinformation from all media sources, is there any wonder the general public has the opinions it has of law and lawyers?


This is thought provoking, but probably a topic for longer reflection. There is surface appeal in splitting the function of bank regulator from monetary aggregate management, but the problem is that the management of reserves in the bankings system is one of the two tools the Fed has for managing the monetary supply, the other being the purchase of federally issued or backed debt (or open market operations), and assuming no helicopter drops. To split the two functions would require deep changes in monetary policy management, essentially requiring the monetary manager to develop an entirely new channel for money creation and absorption. Which would be cool, but risky. Which is why I say longer reflection is in order. The MMT gurus have developed radical perspectives on that.

There is also a whole operations segment of the Fed that goes unnoticed in the press that attends to the technical and logistical nuts and bolts of how efficiently money moves around the country through banks, and splitting the two would require again some thought about how that gets split or allocated.

Dryly 41: Countrywide was a thrift holding company and had a thrift subsidiary regulated by the OTS. It used to be a financial holding company with a national bank subsidiary before switching charters.

The regional reserve banks have the primary supervisory authority. Almost all examiners report to the reserve banks and the FRBSF unquestionably was responsible for the day-to-day supervision of Countrywide.

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