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Overhaul Bill Leaves Fed With Even More Power

Fed Chairman Ben Bernanke was confirmed for a second term in January — but with a sizable number of "no" votes. Christopher Dodd, the Senate Banking Committee chairman, had wanted to strip the Federal Reserve of most of its powers. But his latest proposal gives the Fed more power than it has ever had.
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Above: Fed Chairman Ben Bernanke was confirmed for a second term in January — but with a sizable number of "no" votes. Christopher Dodd, the Senate Banking Committee chairman, had wanted to strip the Federal Reserve of most of its powers. But his latest proposal gives the Fed more power than it has ever had.

Talk about awkward. For much of the past year, members of Congress have routinely taken to criticizing the Federal Reserve System, blaming the central bank for failing to regulate banks and the housing market more stringently in the run-up to the financial crisis.

But it looks increasingly like any financial services legislation that Congress passes this year will give the Fed much more power. "It's almost inevitable, even though there's a lot of dissatisfaction with the Fed," says Craig Pirrong, a finance professor at the University of Houston.

Christopher Dodd (D-CT), the Senate Banking Committee chairman, has been among the Fed's loudest critics. Legislation he put forward in November would have stripped the Fed of much of its authority by blocking it from supervising banks.

But Dodd's newest proposal, which he introduced at a news conference Monday, would give the Fed a bigger role than it currently has. Not only will it continue to regulate banks, but it will also start looking over the books of other large financial institutions. And it will be given new powers to protect consumers.

"It's going to be awkward for members of Congress, after bashing the Fed, to turn around and give it more power," says Phillip Swagel, a former Bush Treasury official now teaching at Georgetown University.

A Convenient Scapegoat

The Fed has been the focal point for much of the public anger inspired by the financial crisis. Rep. Ron Paul (R-TX), the erstwhile presidential candidate, published a best-selling book last fall called End the Fed. He also co-sponsored a proposal, which the House passed as part of its financial services legislation in December, that would subject the Fed to greater outside scrutiny.

"The Fed is seen as the economic policymaker," says Vincent Reinhart, a resident scholar at the American Enterprise Institute and former director of monetary affairs at the Fed. "If you've got to be angry at somebody, the Fed is easy to be angry at."

The Obama administration pushed the idea last year of putting the central bank in charge of all "systemically important" (translation: really big) financial institutions. But the House instead voted to curb the Fed's moneylending authority as part of its legislation in December.

And the Senate took out its frustration when confirming Ben Bernanke for a second term in January, giving him the largest number of "no" votes any Federal Reserve chairman has received in the bank's nearly century-long history.

Lobbying For The Fed

But Bernanke was ultimately confirmed easily. And both the banking lobby and the Treasury Department want to see the Fed play an enhanced role in the new financial order. Treasury Secretary Timothy Geithner previously served as president of the Federal Reserve Bank of New York.

"The Treasury has been working extremely closely with the Fed throughout the entire period of the financial crisis," says Pirrong, the Houston finance professor.

No existing agency or any new body that Congress might create could boast greater knowledge about the inner workings of large financial institutions.

"Only the Fed has the mandate and ability to look at the economy broadly," says Swagel, the former Treasury official.

Dissatisfaction Remains

Allan H. Meltzer, an economist at Carnegie Mellon University and author of two books on the history of the Fed, says the bank has been an "indifferent" regulator.

"I'm sure they'll start out with a new broom and be much stricter for a while, but then they'll go back to business as usual," he says.

William Greider, national affairs correspondent for The Nation and author of a book critical of the Fed, says that Congress has ducked the largest issues. Rather than moving around authority for regulating financial institutions, he says, it should be making changes that address the size and behavior of banks directly.

"If Congress doesn't have the nerve to reach in with real regulation and change the behavior of the banks, is it really reasonable to expect that the Federal Reserve will do this on its own?" Greider says.

Can the Fed Protect Consumers?

Perhaps the greatest surprise is that Dodd wants to give the Fed new responsibility for protecting consumers. Currently, the Fed shares such duties with a half-dozen other federal agencies.

The Obama administration wanted to create a new agency devoted to consumer protection, which the House agreed to. But Senate Republicans balked at the idea, so Dodd spent weeks trying to figure out a good home for a consumer regulator with new powers before finally opting for the Fed.

"The Fed isn't ideal because of their very poor consumer protection track record over the last 20 years," says Travis Plunkett, legislative director for the Consumer Federation of America.

Plunkett concedes, however, that the Senate will not vote to create a new agency. And he says that the Fed's record on consumer issues has improved over the past couple of years.

Left All Wet At The Prom

Reinhart worries that Congress, by arguing about where consumer protection should live rather than outlining what new powers it should have, may be setting the Fed up for failure.

"The discouraging thing for me is if you think the Fed won, it won exactly the same way Carrie wins as prom queen in the movie," he says, "not with the expectation of success but with the expectation of failure."

And no matter how much it ultimately strengthens the Fed in terms of financial regulatory powers, Reinhart argues, Congress will still want to be able to say it did something to punish the central bank as well.

"The Fed can't come out of 2010 as an institution that has more powers absolutely," he says. "They're going to have to give something else up."

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