The cover of the October 2010 issue of Bloomberg Markets magazine shows a photo of Ben Bernanke, chairman of the Federal Reserve, testifying before the Senate Banking Committee on Capitol Hill in Washington, D.C., on December 3, 2009. Photograph: Brooks Kraft/Bloomberg Markets via Bloomberg
The new financial regulation law gives the Federal Reserve chairman the authority to force banks to raise capital and tighten lending -- just as he's trying to steer monetary policy in the opposite direction.
In November 2009, Senate Banking Committee Chairman Christopher Dodd advanced a radical proposal: to create a super-regulator that would take over most of the bank supervision that had been done by the Federal Reserve System, the Federal Deposit Insurance Corp. and other agencies.
Dodd had been a harsh critic of the Fed and its chairman, Ben S. Bernanke, declaring in July 2009 that the central bank's supervision of financial services had been an "abysmal failure," Bloomberg Markets magazine reports in its October 2010 issue.
In January 2010, the U.S. Senate approved Bernanke for a second four-year term by a tally of 70 to 30 -- giving him the most negative votes any nominee had received since the chamber started confirming Fed chiefs in 1978.
Six months later, when President Barack Obama signed into law a 2,300-page bill overhauling financial services regulation, the super-regulator had been forgotten. Instead, the Federal Reserve had acquired new regulatory heft, and Bernanke had emerged as the most powerful Fed chairman ever -- with more authority even than his legendary predecessor, Alan Greenspan, who had chaired the Fed for 18 years.
For all of the heat Bernanke took for failing to see the gathering credit storm in 2007, lawmakers -- with a few exceptions -- have come to appreciate the actions he has taken to rescue the banking system and the economy in the past two years. He has pushed interest rates as low as they can go and vowed to keep them there until the employment picture improves. Last week at a Fed meeting in Jackson Hole, Wyoming, he said the Fed was ready to provide still more stimulus if needed.
Vote of Confidence
"When the dust settled, Congress realized that Bernanke and the Fed knew what they were doing," says Mark Gertler, a New York University economics professor who did research with Bernanke, a former Princeton University professor, on the causes of the Great Depression. "The power of any Fed chairman is ultimately based on the perception by Congress that he will use it prudently. He has this reputation."
Under the Wall Street Reform and Consumer Protection Act, known as the Dodd-Frank law, Bernanke's Fed gains powers never before housed in one regulator. The central bank remains the supervisor of 5,000 U.S. bank holding companies and 830 state banks.
The law gives it new authority to control the lending and risk taking of the largest, most "systemically important" banks. Among them: investment banks Goldman Sachs Group Inc. and Morgan Stanley, which became bank holding companies in September 2008.
Thrift Regulator
The Fed gains authority over about 440 thrift holding companies and will also regulate "systemically important" nonbank financial firms, including, analysts say, the biggest insurance companies, Warren Buffett's Berkshire Hathaway Inc. and General Electric Capital Corp., the financial unit of GE.
The Fed is now required to look for evidence that practices in the banking system threaten the country's financial stability and, if necessary, take action to put a stop to those practices. It's also obliged under the law to administer stress tests at the biggest banks every year to determine whether they need to set aside more capital.
The law prescribes that those banks write so-called living wills, approved by the Fed, that would make it easier for the government to break them up and sell the pieces if they're suffering from a Lehman Brothers-style meltdown.
Bernanke's Fed will also house and fund a new federal consumer protection agency, although it will operate independently. The Fed will even have the power to tell U.S. banks how much they can charge merchants when a consumer uses a debit card to buy a suit or a sack of groceries. Regular credit cards will be the responsibility of the new consumer agency.
"?Enormous Powers'
"There are an enormous number of powers given to the Fed," says Vincent Reinhart, who was the Fed's chief monetary policy strategist from 2001 to 2007. "The Fed has a very powerful and very broad mandate."
That kind of power was just what Senate opponents of the financial regulation bill wanted to deny Bernanke, who declined to comment for this story.
"Augmenting the Federal Reserve's authority risks burdening it with more responsibility than one institution can reasonably be expected to handle," Alabama Senator Richard Shelby, the ranking Republican on the Senate Banking Committee, said at a hearing in July 2009. "In fact, the Federal Reserve is already overburdened with its responsibility for monetary policy, the payment system, consumer protection and bank supervision."
Shelby also raised the issue of the inherent conflict between the Fed's role in setting interest rates and its job of bank supervision.
Toxic Mixture
"The mixing of monetary policy and bank regulation has proven to be a formula for taxpayer-funded bailouts and poor monetary policy decisions," Shelby said.
The Fed's role as a bank regulator dates to its creation in 1913, in the wake of another financial crisis: the Panic of 1907. It originally supervised only state banks that chose to operate under a Federal Reserve charter.
Its bank supervisory duties were expanded with the 1933 passage of the Glass-Steagall Act, which, in addition to splitting apart commercial and investment banks, established the FDIC to insure deposits and required bank holding companies to submit to audits by the Fed.
One opponent of giving the Fed new regulatory power is former chairman Greenspan.
"The additional power that the Fed has been given I had not been in favor of," he told Bloomberg News on July 16. "I do not think they can actually prevent the next crisis."
Bold Steps
As Bernanke, 56, assumes his new responsibilities, he continues to take bold and unprecedented steps in the Fed's traditional areas of responsibility: managing the money supply and setting interest rates. To rescue the banking system and stimulate economic activity, the Fed has for more than two years been buying bank and government debt, swelling its balance sheet to more than $2 trillion.
With the crisis past, the Fed by early 2010 had decided to let the securities-buying program wind down, shrinking its balance sheet as the bonds it held matured. The Federal Reserve Bank of New York estimated in March that more than $200 billion of agency debt and mortgage-backed securities held by the central bank would mature or be prepaid by the end of 2011.
Bernanke reversed the decision to stop buying securities on Aug. 10. The central bank's Federal Open Market Committee announced it would replace maturing bonds with longer-term Treasuries, explaining that the economy had weakened since June and it didn't want to add to the problem by driving up interest rates.
Jackson Hole Assurance
"In particular, the Committee is prepared to provide additional monetary accommodation through unconventional measures if it proves necessary, especially if the outlook were to deteriorate significantly," Bernanke said Aug. 27 at the Kansas City Fed's annual monetary symposium in Jackson Hole.
Buying bonds pushes yields on Treasury notes lower, which forces down mortgage rates and other long-term borrowing costs. The average rate of a 30-year fixed-rate mortgage dropped to a record low of 4.36 percent in the week ended on Aug. 26, from 4.42 percent the week before, according to mortgage packager Freddie Mac, which began compiling the data in 1971.
The yield on 10-year Treasury notes touched a 19-month low on Aug. 25. The yield dropped to 2.52 percent on Aug. 30 from 2.65 percent late on Aug. 27.
Sending a Message
"The simple option of reinvesting the proceeds of maturing assets will not have a huge impact on the scale of market liquidity," says Lena Komileva, an economist at Tullett Prebon Plc, a London brokerage firm. "But it will send the message that the Fed is still in easing mode, which may create an appetite for risk and borrowing."
William Ford, a former president of the Federal Reserve Bank of Atlanta who now teaches at Middle Tennessee State University, calls the Fed action "a wrong move" that will have little impact except to increase the losses the Fed suffers on its portfolio of long-term Treasuries when interest rates rise.
"They are sticking their foot deeper in a liquidity trap," Ford says. "It will not cause any lending."
Bernanke's use of nearly every tool at his disposal to stimulate economic growth could conflict with his new job as regulator-in-chief, says former Fed Governor Lyle Gramley. "If the regulators were to get very tough right away and make major changes in liquidity and capital requirements, that could be a problem," he says.
Hitting GDP Growth
Mark Zandi, chief economist at Moody's Analytics, says any move by the Fed to increase reserves against bad debt will hurt economic growth.
"The higher the capital ratios, the greater the hit to bank profitability, credit growth and GDP growth," he says. "The near-term consequence will be to slow growth."
Bernanke says his examiners are working with the nation's financial institutions to minimize the economic impact of tougher regulation.
"Our message is clear," he said on July 12 at a meeting of small-business owners. "Consistent with maintaining appropriately prudent standards, lenders should do all they can to meet the needs of creditworthy borrowers. Doing so is good for the borrower, good for the lender and good for our economy."
Bernanke and his supporters triumphed over the opponents of expanding the Fed's regulatory power by exploiting the institution's historical prestige.
Fed Independence
"The Fed ended up on top because Democrats and Republicans can agree that its independence is more significant than that of any other agency," says John Silvia, chief economist at Wells Fargo Securities and former chief economist for the Senate Banking Committee.
Bernanke says it's important that the Fed continue to be the country's main bank regulator because no agency knows the banks better.
"Because of its wide range of expertise, the Federal Reserve is uniquely suited to supervise large, complex financial organizations," Bernanke told a hearing of the House Financial Services Committee on March 17.
The Fed chief has taken his message to the public in a series of appearances, including a profile on CBS TV's 60 Minutes in March 2009 and a half dozen speeches and question- and-answer sessions.
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