federal-reserve-board-seal.pngLast March, Jane shared a conversation with former banking regulator Bill Black, in which Black had pretty harsh words for the Federal Reserve as a regulatory agency:

Regulators are deeply inferior within the institution. "Real men" at the Fed are economists and they do monetary policy. They dine with top bankers on fine china. They play squash on the Fed squash courts. Fed regulators have no power within the institution and the institution is inherently hostile to vigorous regulatory action against the big banks.
Economists in general, and Fed economists in particular, are a major cause of the financial crisis. Their philosophies and theories shaped deregulation and desupervision. They promised that "private market discipline" and "efficient markets" would produce growth and safety. The Fed’s economists’ research during the run-up to the crisis (A) ignored everything important, e.g., it denied the existence of a bubble, (B) praised the worst possible practices, e.g., Greenspan’s praise of subprime lending and financial derivatives and his article lauding "equity stripping", (C) was full of undeserved self-praise, e.g., re "the Great moderation" that Fed policies (and neo-classical economics) had purportedly created, and (D) proved no practical assistance to Fed examiners/supervisors to deal with the crisis. . .
The Fed’s regional offices (the FRBs) have strong conflicts due to the pervasive role of the industry in running the FRBs. Many of the FRB presidents were picked because of their ideological opposition to regulation.

For those who’d like some supporting evidence of Black’s comments, let us turn to the Federal Reserve Board’s own Inspector General, Elizabeth Coleman. Last week she submitted a report to the Fed’s Board of Governors, and it wasn’t pretty. Per Bloomberg (h/t Calculated Risk):

Federal Reserve examiners failed to rein in practices that led to losses from excessive real estate lending at two banks in California and Florida that later closed, the central bank’s inspector general said.

Riverside Bank of the Gulf Coast in Cape Coral, Florida, “warranted more immediate supervisory attention” by the Atlanta district bank, Fed Inspector General Elizabeth Coleman said in a report to the central bank’s board [pdf]. In overseeing County Bank in Merced, California, the San Francisco Fed should have taken a “more aggressive supervisory” approach, Coleman said in another report, also dated Sept. 9.

But Calculated Risk notes that Coleman didn’t go nearly far enough. The IG report’s comment about "more immediate supervisory attention" referred to 2007. Said CR (emphasis his):

"Emerging problems" in 2007? I strongly believe that action should have been taken much sooner – at least by 2005 – because of 1) concerns about the housing market, and 2) the concentration of loans in residential real estate. . . .

The signs of excessive risk were apparent in 2003 to 2005. The Fed is aware of the risks, especially of a high growth strategy with a high loan type concentration. If the regulator was unable to step in sooner and evaluate the risk, then the regulatory process is flawed – and the regulator has already failed. It was too late by 2007.

The inability of the Federal Reserve and the Inspector General to recognize the need for tighter supervision in 2005 or earlier is a serious oversight failure.

As masaccio reminded us on Sunday, "rewarding failure is the new American ethos," so giving the Fed more oversight responsibilities is obviously the way to go, right? The comments he cites from Gretchen Morgenstern match those of Black and CR: "The Federal Reserve Board, for example, wants to become the financial system’s uber-regulator, even though its officials did nothing as banks made deadly decisions to lend recklessly and leverage themselves to the max."

But why should this be a surprise, when the Fed is largely run by the banks, for the banks? Yes, the Fed’s Board of Governors is appointed by the President, but the regional Federal Reserve banks are run by boards and presidents largely appointed by the banks themselves, either directly or indirectly.

I’m all for stronger regulation of the financial industry, but someone please explain to me why the Fed is the one to take on this job? They’ve proven to be ineffective at what regulatory functions they already have — even in their own IG’s opinion — and more of what amounts to self-regulation by industry doesn’t seem to be terribly helpful either.

Senator Dodd, I hope you’ve got some other ideas, because clearly we need them.