June 23, 2009

The Fed has a conflict of interest if overseeing systemic risk.

Sir Frederic Mishkin in “Why all regulatory roads lead to the Fed” June 23 fails to mention the most important reason why the Fed should not be the systemic regulator, namely that as a regulator it is also a producer of systemic risks and has therefore a clear conflict of interest.

The current crisis occurred, primarily, because of those so poorly crafted minimum capital requirements for banks that originated in the Basel Committee and that created immense incentives for anything that could get hold of an AAA rating, such as AIG and the securities collateralized with subprime mortgages. The sole fact that most still speak of “excessive risk taking” while the truth is that the problems derived from risk adverse investors taking refuge in instruments that had been faultily classified as risk-free, is just an example of that peer solidarity among regulators that creates opacity and puts the world on a wild-goose chase it cannot really afford.

I would prefer to outsource any systemic risk vigilance to a totally independent entity, perhaps, given its global implications, even one paid and supervised by the United Nations, than having that function placed in the hands of regulators and that as far as this type of risk I trust even less than I would trust a Wall Street firm.