The Administration’s regulatory restructuring proposals released in June envision the Federal Reserve taking on the role of Systemic Risk Regulator. On July 9th, Fed Vice-Chairman Douglass Kohn testified before the House Financial Services Subcommittee on Domestic Monetary Policy and Technology at a hearing entitled: “Regulatory Restructuring: Balancing the Independence of the Federal Reserve in Monetary Policy with Systemic Risk Regulation.” A panel of civil society experts also spoke.

Kohn insisted that the new powers would be a modest, incremental addition to the Fed’s existing duties as supervisor of bank holding companies, asserting that most firms that would be designated “Tier 1” are already under the Fed’s supervision. Michael Castle (R-DE) charged that if the Fed has been supervising bank holding companies such as Citi, they “did not succeed,” an observation echoed by others who criticized the Fed’s track record of recognizing risk and acting before crises. Kohn also stressed the synergies between the Fed’s existing statutory objectives of maximum employment and price stability, and its proposed role as systemic risk regulator; panelists were split on this issue: some believed the new responsibility would dilute the Fed’s mission and threaten its independence.

Dr. James Galbraith, a government professor at LBJ School of Public Affairs, questioned the proposal’s constitutionality: as Brad Sherman (D-CA) pointed out, the Fed is constituted by regional Fed district banks with boards formed by member banks themselves, represented by the Federal Open Market Committee, whose constitutionality was questioned in the 1970’s and never resolved on legal merits; the examiners would reside in the regional Fed district. He warned there may be a conflict of interest between the member banks and the interest of system stability and/or other Tier1 firms who are not member banks. He proposed to instead give enforcement authority to an “a tough cop who is entirely autonomous,” such as the FDIC.

Subcommittee Ranking Member Ron Paul (R-TX) extolled his proposal, H.R. 1207, which would subject the entire Fed to GAO audits; currently its monetary policy operations and dealings with foreign central banks and foreign authorities are off-limits. Kohn’s concern: “That would be perceived as impinging on our independence to meet our objectives.”

Some, including Leonard Lance (R-NJ) and Committee Ranking Member Spencer Bachus (R-AL), feared the notion of identifying systemically significant firms altogether , citing the moral hazard—encouragement of imprudent risk-taking through implicit government bailouts—associated with the Too Big to Fail Doctrine. The renowned economist, Dr. Allan Meltzer, quipped, “Capitalism without failure is like religion without sin…How can you limit the risks that some banks are going to take? Make them bear the risks.”