Regulation Reform: The Consequences of Dodd-Frank Part II July 15, 2010, Bob Eisenbeis, Chief Monetary Economist
In this second of a series devoted to the D-Fran financial regulatory reform bill, let us tackle an obvious issue that represents an egregious abuse of a regulatory agency by Congress. That is the creation of the Bureau of Consumer Financial Protection (BCFP) within the Federal Reserve. Interestingly, this is the tenth title of the bill but the BCFP is the first accomplishment cited in the comprehensive summary of the bill's provisions on the House Financial Services website.
As we have argued previously, while the crisis exposed financial service firms' abuses of consumers, failures of consumer protection were not a major cause of the crisis. D-Fran establishes for the first time a new agency within the Federal Reserve, whose head would be appointed to a five-year term by the President. The Bureau would be totally independent from the Board of Governors, except for the fact that it would be funded by the Federal Reserve. The BCFP would have the authority to promulgate regulations pertaining to consumer protection in financial services and to promote financial literacy; it would also have enforcement powers. The Bureau would be authorized to establish branch offices in cities where Federal Reserve Banks are located, and elsewhere, as it sees fit.
Without going into great detail, the Act would make the new office totally independent of the Federal Reserve Board of Governors. In essence, Congress has created a new agency that is funded by using the Federal Reserve System as an off-budget piggy bank. One must wonder why the Board of Governors didn't pull out all the stops to head off this nonsense proposal.
The Federal Reserve's budget is not considered part of the government budget, and thus its expenditures are not subject to appropriations. The Federal Reserve historically has strongly resisted Congressional attempts to use its balance sheet for purposes other than the conduct of monetary policy or its other mandated responsibilities.
Budget independence is one of the cornerstones of central bank independence. However, the camel's nose first appeared under the tent in 2000 when Chairman Greenspan, in a political compromise, agreed to a one-time transfer of $3.752 billion of the Fed's capital surplus to the Treasury under the Consolidated Appropriations Act of 2000, to reduce the national deficit. This was a pure accounting gimmick of the worst kind that treated the funds as revenue to the government for budget accounting purposes, thereby cutting the deficit, despite the fact that it was really just an intergovernmental transfer.
Of course, the revenue implications of this accounting trick aren't quite as costless as they may first appear. Remember that the Federal Reserve annually returns excess earnings that it receives from interest paid on securities held in the Federal Open Market Committee's System Open Market Account, over and above any operating expenses and transfers, to a surplus capital account. Therefore, funding for the BCFP reduces the amount of that transfer and thus reduces what counts as federal government revenue in the future, and thereby potentially increases the deficit.
What has happened now is that the tent door has been thrown wide open with this new bill, creating a huge potential breech in the Federal Reserve's independence. Congress has hijacked the Federal Reserve's balance sheet and opened it to all sorts of potential uses and nonsense to support Congress' pet projects, without Congress having to budget or pay for those activities. While the Act nominally grants the Board immunity from responsibility, both legally and policy-wise, the BCFP's activities will be tied both financially and in terms of reputation to the Board of Governors and Federal Reserve System. And what goes wrong will ultimately stain the central bank's reputation.
This new Bureau will be responsible not only for promulgating and enforcing any existing or future consumer financial-protection laws, but also will be charged with funding consumer literacy programs, promoting fair lending, establishing two new offices to promote informed decision making with regard to financial-service products for members of the armed forces and for "older Americans," and conducting and disseminating research on those issues. The Office of Financial Protection for Older Americans will also be responsible for providing one-on-one counseling and retirement planning services for covered individuals. Again, hiding behind the reputation of the Federal Reserve, those activities will not be subject to the normal high standards for research, for example, but will be labeled as Federal Reserve research just the same.
In terms of funding, the Congress has now interjected itself into the Federal Reserve's budget process by tying the budget for the new agency not to the costs of accomplishing its mission but to a maximum percentage (to be adjusted annually and capped at 12% plus additional adjustments tied to the employment cost index) of the Federal Reserve System's operating expenses reported in its 2009 annual report, which were $3.7 billion. In 2013, the Bureau's budget could be as large as $480 million, which would make its budget potentially 25% greater than that of the Board of Governors and larger than those of all but two of the twelve Federal Reserve Banks (New York and Atlanta).
Now, given the essentially open-ended nature of this new Bureau's responsibilities, it is hard to figure whether the new agency will be adequately funded or not. It will be required to file its budget with the Office of Management and Budget and report to the Comptroller General of the US with respect to the effectiveness of its internal controls, but its budget will not be subject to approval by those entities. In addition, there will be a separate fund created by the Federal Reserve to hold funds transferred to the Bureau, and Congress has specifically exempted those monies from being regarded as government funds or subject to being scored as appropriated funds for budget purposes (read this as another accounting gimmick).
The BCFP will also have independent authority to conduct consumer compliance examinations of all financial institutions. The Bureau is required to coordinate with other bank-examination authorities with respect to the timing and scheduling of prudential examinations, but those exams will be conducted by separate staffs, and one can only imagine how the working relationships will evolve between the staff of this new Bureau and the supervisory staff of the Board, or the other agencies for that matter.
As one delves into the scope and responsibilities of the BCFP, it is clear that its creation will at least solve one of the key problems that has faced Federal Reserve Banks as their role in check processing has declined. And that is what to do with all the excess office space that they have not been able to lease out. In some cities, like Boston, the Federal Reserve is a minority tenant in its own building, and in other cities like Detroit, Houston, Birmingham, and Miami, just to name a few, its former branch offices are essentially vacant. That problem has just been solved by this new proposal. The main inhabitants of Federal Reserve facilities will be the staff of this new Bureau, and again, the costs will be hidden.
Bottom line is that by not strongly resisting the establishment of this agency, the Federal Reserve has lost a measure of independence and risks having its reputation tied to the new Bureau without any ability to influence or exercise control over the regulations it promulgates, the enforcement actions it takes, the supervisory and compliance philosophy it adopts, the reports it generates or the budget under which it operates. This is a devil’s bargain that implies a high cost to our central bank and great risk as the price for retaining supervisory authority over small bank holding companies.
More broadly, now that Congress has found a way to fund new agencies without appropriation of taxpayer funds or accountability, it will only be a matter of time before it conceives of other new initiatives. One can imagine, for example, that with special funds having been established within the Federal Reserve to support consumer initiatives, it isn't a far stretch to argue for targeted lending programs, to mandate the continued purchase of mortgage-backed securities to support the housing market, or to fund loan-remediation programs. The structure of this new Bureau is bad. The potential for future expansion of off-budget programs is significant, and it is but one example of the kind of mischief that is contained in the bill and that is unrelated to the financial crisis.
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