Bernanke Outlines Future of Regulation, Sort Of

Fed Chairman Ben Bernanke has been speaking via satellite this morning since 9:30 AM EST before the Federal Reserve Bank of Chicago Conference on Bank Structure and Competition in Chicago.  But the focus of this speech is the more forceful and stringent regulation that financial firms can expect from here on out.

The term used throughout the speech that you need pay attention to is ‘systemic risk’ and ‘systemically important.’ This is addressing the notion of ‘too big to fail,’ as this ‘systemic’ verbiage was used throughout the speech.   This is starting to sound more and more like the second wave of changes in the financial system after the stress tests and after the bailouts.

There are some basic summary comments here:

Bernanke noted the Fed is taking steps to boost supervisory practices and regulators need to be both more vigilant and forceful.  The stress tests have been rigorous and collaborative and could improve supervision.  The weakness in oversight has been revealed by the recent credit crisis and the crisis underscores the liquidity of banks. He later noted that the crisis revealed serious deficiencies. The Fed is in what Bernanke called an “extensive introspection phase.”

Bernanke also discussed that banks need to overhaul their risk management and did note that pay policies need to be overhauled.  Interestingly enough, Bernanke noted that current laws are hampering supervision.  A new regulator is needed to monitor large and systematic risks, and the Fed has stepped up efforts to monitor safety and soundness and to identify risks.  The biggest notation here on the stress tests they are not solvency tests.

This new regulation may or may not hold up through time.  It is hard to know how the old term of “money center banks” will work when the regulators keep going back to knocking down the “too big to fail” notion as this means that regulators want no more single financial failure to be able to take down the entire financial system.  When you have banks with more than 10% of the US deposit base and banks, brokers, insurance firms, and money managers with trillions of dollars worth of exposure, then something has to give.

Bernanke’s full speech is here.

There also has to be at least some part of a free-market theorist that might cringe at the notion of higher regulation and more vigilant regulators.  Unfortunately, there is also the fresh lesson of history that is still front and center that shows how much having institutions that are “too big to to fail” poses more risks than the market needs.

Many of the battered banks have already recovered exponentially from their lows.  The question to ask now is if the banks of tomorrow will look and act more and more like the utilities of old rather than act as financial powerhouses.

JON C. OGG