Like all crises, the one plaguing global finance has a multitude of factors behind it. Exotic financial instruments and greedy bankers have suffered their share of blame, but there’s a broader issue that ties it all: central banks.
To that end, US President Barack Obama’s financial regulation reforms, announced on Wednesday, are perhaps in the right direction. We say “perhaps” because, like everything else Obama does, it’s unclear how far these changes will go. The President’s penchant for satisfying every political side continues to hound his policymaking.
The good news is that Obama’s reforms give the US Federal Reserve new powers over institutions considered too big to fail. In a system where every firm is checked by a myriad of regulators, this is a step towards consolidation.
Illustration: Jayachandran / Mint
There are lessons here for India. Obama’s reforms discard the notion that a central bank must only target inflation. A mixed mandate such as the Reserve Bank of India’s (RBI), maligned for years, now looks benign. Yet, regulatory consolidation in India is missing: Last year’s Raghuram Rajan report noted the importance of this, but appeared to favour a new oversight agency.
Obama, too, favours an oversight body: the Financial Services Oversight Council, staffed by the US treasury department. But this new super-regulator is where the bad news begins. Instead of consolidating powers with the Fed, such an attempt actually disperses oversight. We come back to the political dilemma: Obama giveth the Fed some powers with one hand, but taketh from the other—all to appease hordes of Congressional subcommittees and financial lobbies.
What’s worse, there’s no mention of the Fed’s easy-money policy. Divorcing interest rates from financial markets is like trying to split two sides of the same coin. Obama seems to have forgotten how the Fed’s punchbowl distorted financial incentives.
Instead, he tries to address the financial meltdown by looking at markets alone. Consider that over-the-counter (OTC) derivatives, such as the credit-default swaps (CDS) at AIG, will no longer escape regulation. Consider also that rules for money market funds—where the post-Lehman panic first began— will be strengthened. But overseeing derivatives and funds doesn’t make finance hunky-dory. Deeper causes lie behind the crisis, the deepest revolving around the Fed.
Both in India and in the US, policymakers are inclining towards dividing powers between an agency regulating financial markets and a central bank regulating interest rates. Yet that only leaves systemic risks unaddressed.
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