The Growing Power of the Federal Reserve

While the Federal Reserve refuses to allow an outside audit, the Dodd-Frank Bill provides huge new arbitrary power to them. Oliver Hart and Luigi Zingales provide a bit more information on the new power they have been given:

Now that the Dodd-Frank financial-reform bill has become law, the real battle begins. Despite the law’s 2,000 pages—or possibly because of them—there is much ambiguity about what its eventual impact will be. The Wall Street Reform and Consumer Protection Act, as the law is officially known, grants the Federal Reserve enormous regulatory power. The Fed can now unilaterally decide that any financial institution is “systemically important”—meaning that its failure could destabilize the financial system itself—and impose any sort of regulation on it, such as requiring that it hold more equity capital, limiting the amount of short-term debt it can issue, forcing it to write up a living will, and so on.


Unfortunately, the law does not adequately define what “systemically important” means. The largest banks can in theory be exempted from the classification (though this is unlikely), while the smallest hedge funds—should many of them pursue similar strategies, meaning that they might all fail simultaneously—can fall under it. The lack of a clear criterion will likely make the designation difficult to appeal; it’s really up to the feds to decide. For many institutions, the “systemically important” label could amount to a regulatory death sentence, without a fair trial.

Some might argue that giving the Federal Reserve this loosely defined power is a necessary evil. The 2008 financial crisis exposed the financial system’s endemic risks, they claim; inadequate regulation could lead to more instability and further taxpayer-financed bailouts. Yet should we subject the entire financial system to heavy regulation and bureaucratic (if not political) arbitrariness, seeking to avoid a repeat of the financial crisis?

Hart and Zingales, rather than reaching the correct conclusion about the shocking power given the Federal Reserve, that the power should be withdrawn, instead,simply suggest tweaking of the power by calling for the Federal Reserve to announce in advance what minimum capital conditions firms must meet. Some tweaking. This is like battling a standing army by sticking a wad of gum under the shoe of one of the soldiers.

Bottom line: The Dodd-Frank Bill is, for all practical purposes, giving huge power to one man, Fed chairman Ben Bernanke. He will be able to direct the financial sector in a way that will make him the sole member of a very powerful Politburo .