In recent years, and perhaps the past few decades, the federal regulators have essentially been regulated by the very banks they are supposed to regulate. The strong Republican victories in Congress this week aim to reverse this debilitating trend.
Until now, the Fed has been loath to reform the way it does business.
However, in a recent closed-door session, the banks were told by the Fed they need to shape up or get broken up. Citing ongoing probes of currency and interest rate manipulation, tax evasion and violations of U.S. international sanctions, Federal Reserve Governor Daniel Tarullo and New York Fed President William Dudley expressed a deep mistrust of the risk-taking activities by banks and the behavior by its employees during the past six years that followed the worst financial crisis in 75 years.
Further, a recent internal report commissioned by the Fed suggests there is a culture of suppression at the Fed that discourages employees from voicing concerns about the banks they supervise.
Dudley suggested that the behavior by banks seems to be systemic, not the result of isolated rogue actors. He even recommended that senior management be responsible for a substantial portion of the fines and that employee behavior get monitored and published publicly, similar to the manner in which broker-dealers are regulated.
While this sounds good, it comes quite late, as the credibility of the Fed continues to wane. Congressional action might be required to stipulate new practices that ensure financial and economic stability.
The remedies being promoted by the Republicans include: 1) regular audits by the General Accounting Office of the Fed's interest-rate policy meetings and financial operations; 2) a dilution of the Fed's dual mandate
, permitting the Fed to focus more on stabilizing price levels and less on the level of unemployment; and 3) an enforceable culture that permits regulators to monitor banks objectively without fear of reprisal.
Sen. Richard Shelby, R-Ala., will likely be the next chairman of the Senate Banking Committee, which oversees the Fed. Along with Rep. Jeb Hensarling, R-Texas, chairman of the House Financial Services Committee, they will be strong advocates of Fed reform.
Sen. Rand Paul, R-Ky., sponsored a bill to audit the Fed
. A companion measure was passed by the House in September, but Senate Majority Leader Harry Reid, D-Nev., has not permitted it to reach the floor for debate. Six out of 10 Republican members of the Senate Banking committee are among the 31 co-sponsors of the bill, along with Senate Minority Leader Mitch McConnell, R-Ky., who is set to become the Senate Majority Leader. Sen. Ted Cruz, R-Texas, a potential 2016 presidential contender, believes this bill should be included in the top 10 priorities of the 2015 Congress.
Fortunately, there are Democrats who also share the vision of monitoring the Fed more effectively.
Sen. Sherrod Brown, D-Ohio, indicated the Senate Banking Subcommittee on Financial Institutions and Consumer Protection would hold a hearing to investigate allegations that the Fed supervisors are too lax with the banks they regulate. Sen. Elizabeth Warren, D-Mass., was among those recommending this hearing.
In addition to these reforms, certain rules might need to be reexamined. These include: 1) the recent evisceration of Dodd-Frank, which eliminates loan exposure to banks and reduces the level of down payments, and 2) the exclusion of derivative securitization when calculating the permissible ceiling on bank liabilities.
The maximum cap on liabilities is set at roughly 10 percent of the total, which stands at approximately $18 trillion today, according to the Fed. Three banks are closely approaching this level of $1.8 trillion in total liabilities. They are JPMorgan Chase with $1.4 trillion and Bank of America and Citigroup, each with $1.1 trillion.
The extensive $700 trillion derivative market was a key driver of the financial collapse in 2007 and 2008. Allowing unlimited growth of these liabilities does not portend well for our financial and economic well-being.
The Republicans are well-positioned to institute measures that will stabilize our monetary policy, insure the safety of our financial system and promote greater economic certainty. If they do not make significant inroads, winning the presidency in 2016 becomes less likely.
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