Who Will Oversee the U.S. Federal Reserve?

Large-scale financial governance always comes into being with great financial turbulence. Whenever any kind of system is established, there should also be a repair mechanism for that system. The American financial oversight bill, more than a year in the making and more than a thousand pages long, has crossed obstacle after obstacle and finally obtained passage. On the one hand, this blueprint for U.S. financial oversight reform reflects the origins of the crisis and the deficiencies in the American financial oversight system. On the other hand, it also clearly presents the Obama administration's attempt to restore the American financial system and to revive America's financial competitive strength, a stratagem for rebuilding absolute global financial leadership. This is bound to have a broad, deep and long-lasting influence on future international financial oversight systems and even the structure of the global economy.

The U.S. has always put forward its own markets and oversight mechanisms as a model for the rest of the world, but the undeniable facts of the financial crisis have exposed great deficiencies in the American financial regulatory system — deficiencies that led to a calamity and a worldwide financial crisis.

The origins of these shortcomings in U.S. financial oversight are deeply rooted in globalization. In the past twenty years, global economic and financial structures have undergone fundamental changes, and the world economy has entered into an era of financial capitalism. This is central to understanding current global economy and finance, and it also forms the background for the present era of explosive financial crisis. According to preliminary statistics, if the value of all of America's pre-crisis assets were tabulated, the total amount of fictitious capital would have amounted to $400 trillion or $500 trillion, while the U.S. GDP was only $12 trillion to $14 trillion. According to the relationship between cash flow and reserves, America's $12 trillion to $14 trillion in GDP was valued as high as $400 trillion to $500 trillion.

The development of financial capitalism has already severely altered the modes and manifestations of the earlier macroeconomic movements, producing the distinctive features of economic and monetary fictionalization. Under these circumstances, the rise and fall of asset prices, the workings of banks, and all kinds of innovative financial products and risk premiums are exhibiting new behaviors and systematic risks that are different from the past; the fundamental terms, conduction paths and outcomes of monetary policy have also undergone great changes. However, America's financial oversight system and oversight modes have severely lagged behind financial innovations. Tools for measuring financial risk are insufficient and the moral peril of financial speculation on capital is ignored, as are the regulatory deficiencies of banking systems that are linked with capital markets. This caused unlimited financial risk to accrue, such that the collapse resulting from the bursting of the economic bubble exceeded what the financial system was able to bear, exploding at last into a catastrophic crisis.

At the same time, these shortcomings in financial oversight are also related to the system of valuation in American society: neo-liberal economic theory has been the theoretical foundation for American macroeconomic supervision over the last thirty years.

After this crisis, American thinking on crisis management and financial oversight has undergone significant changes. The core objectives of three pieces of financial oversight reform — the “Blueprint for a Modernized Financial Regulatory Structure” of March 2008, the principles of regulatory reform of March 2009 and the recently passed U.S. financial oversight bill — emphasize upgrading the U.S. government's authority, expanding the role of the U.S. Federal Reserve, and controlling excessive speculation on financial capital, with a focus on protecting the interests of investors. The depth and breadth of its reform is unprecedented in the history of the American financial oversight system.

A look at the central content of the recently passed financial oversight reform plan reveals an abundance of characteristics that promote strong intervention, expanded power, problem-solving, closing of loopholes and protecting the public. In particular, the plan emphasizes the increased power and administrative authority of the U.S. Federal Reserve, which leaps from its previous roles as guardian of the purchasing power of the U.S. dollar and protector of the macro-economy to new roles as supreme regulator and watchdog. This reflects America's attempt to shape a new national competitive strength out of financial oversight, reversing the downward spiral of U.S. national credit that resulted from the financial crisis.

The U.S. Federal Reserve, in its roles as macro-economic controller and supreme watchdog, gains the following significant powers: The scope of its oversight expands to encompass all companies that could threaten financial stability; therefore, not only banks but hedge funds, insurance companies and other non-bank financial institutions will be brought under the regulation of the U.S. Federal Reserve. The SEC's [Securities and Exchange Commission] unified oversight plan will be canceled and the U.S. Federal Reserve will replace the SEC in the role of overseeing investment banking companies. Its systematically important payment, transactional and settlement capabilities will become stronger and channels for gaining liquidity will become broader. Finally, the Fed's emergency loan-making power will be revised, increasing its ability to respond to a crisis.

The general direction of U.S. oversight reform deserves affirmation. However, the all powerful oversight mechanism embodied in the huge powers given to the Fed might also raise a few questions. Firstly, would a conflict emerge between the regulatory role of the U.S. Federal Reserve and its role in formulating and implementing monetary policy? Can the Fed continue to preserve its independence on monetary policy while wielding the regulatory scepter? Can the Fed strike a balance between its different policy objectives while avoiding nearsighted behavior? Secondly, who will oversee the Fed? At present, we still cannot hope that the genuinely powerful Fed would come to possess effective checks and balances. As a result, should an error of judgment emerge from this system-wide regulatory mechanism, the potential for harm is all the greater. It became clear in the sub-prime mortgage crisis that there was a close relationship between the eruption of the crisis and poor monetary regulation at the U.S. Federal Reserve. From this point forward, how can the Fed regulate its own decision making? This will impact the question of how to manage construction and policy for international regulatory systems.

[Zhang Monan is an assistant researcher in economics at the State Information Center.]