Bernanke Proposes New Oversight

Speaking before the House Financial Services Committee, Fed Chairman Ben Bernanke proposed a new regulatory mechanism to monitor and respond to broad risks affecting the financial system. This would consist of a panel that would exist outside of the Fed, tapping resources from all agencies with current oversight over the financial system.

The proposal is a move by Bernanke to thwart efforts to give the Fed more power. It also increases the potential penalties for taking excessive risk by imposing losses on shareholders and bondholders.

Bernanke is bringing forth some good ideas. Particularly, his call for coordination across multiple agencies is something that should fortified by regulation. Clearly, the joint actions by the Fed and the Treasury Department have helped to prevent the current crisis from becoming worse. This said, turf wars in Washington may make accomplishing this goal difficult in the future.

His proposal also calls for creating a special resolution process for winding down a failed bank or financial institution. Though good in concept, handling toxic assets remains difficult in reality. The government continues to hold large stakes in Citigroup (C - Analyst Report) and Bank of America (BAC - Analyst Report), with no clear exit plan existing. Taxpayers also own AIG (AIG - Analyst Report) and may never see their investment paid back.

Which brings us to Bernanke's call to hold shareholders and bondholders accountable for a financial firm's losses. It's great in concept because capitalism works by punishing those who make bad decisions. In reality, the political pressures placed upon the oversight committee will make wiping out investors in a future failed firm difficult.

Over the short-term, today's proposal will not have meaningful impact on financial institutions. Over the long-term, it could lead to new regulations that would impact how big firms can grow.

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