Will the U.S. Federal Reserve Become a Systemic Risk Regulator?

Treasury Secretary Timothy Geithner has said that the Obama administration will move forward with an overhaul of financial regulation, less than a year after an abortive blueprint for financial regulation from the previous administration.

A massive financial crisis and hundreds of billions of dollars in bailouts for financial firms were interposed between these two attempts, fundamentally altering the terms of discussion.

Some observers claim that companies like AIG and Citigroup became too big to fail – that is, “systemically significant” – and thus require special regulation. The Obama administration’s plan will include a keystone role for the U.S. Federal Reserve in monitoring and addressing broad or systemic economic risks.

In a op-ed in The Wall Street Journal, former chairman of the Federal Reserve Alan Greenspan argues that state capitalism is not the right prescription to the current financial crisis: “However, the appropriate policy response is not to bridle financial intermediation with heavy regulation. That would stifle important advances in finance that enhance standards of living. Remember, prior to the crisis, the U.S. economy exhibited an impressive degree of productivity advance. To achieve that with a modest level of combined domestic and borrowed foreign savings (our current account deficit) was a measure of our financial system’s precrisis success. The solutions for the financial-market failures revealed by the crisis are higher capital requirements and a wider prosecution of fraud – not increased micromanagement by government entities.”

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