WASHINGTON — In a speech that amounted to a repudiation of congressional efforts to transform the regulatory system for banks, Federal Reserve Board Gov. Kevin Warsh suggested Wednesday that lawmakers were preoccupied by side issues.
In particular, Warsh said that lawmakers are spending too much time attempting to combine regulators instead of focusing on more critical concerns. "There are doubtless efficiencies to be gained in sharing best practices, integrating operations and minimizing regulatory gaps among regulators," he said during a speech to the New York Association for Business Economics. "But it is far from obvious that real regulatory reform hinges on figuring the optimal number of regulators or the precise composition of an oversight council."
The remarks served as a pointed critique of issues that have divided lawmakers in both chambers of Congress, including whether there should be a single financial regulator — as some Senate leaders have advocated — and which agencies should be represented on a council that oversees systemic risk.
The speech's language was particularly strong for an official representing the Fed, which has been in the center of populist furor in recent months over the central bank's role in the financial crisis. The Senate Banking Committee is considering stripping the Fed of its banking supervisory powers.
Warsh also used the speech to take policymakers to task for not addressing the fate of the government-sponsored enterprises as they tackle regulatory reform.
"The mortgage finance system is owed far stricter scrutiny to gather a fuller appreciation of the causes of the crisis," Warsh said. "Ultimately, if the diagnosis of the crisis fails to account for some of the broader failings of public policy, of which the GSEs are just one part, the prescription is unlikely to be effective."
When he was a White House economic adviser nearly a decade ago, Warsh advised the Bush administration on ways to slim down Fannie Mae and Freddie Mac. His comments on Wednesday are likely to strike a chord with Republicans who have assailed Democrats for essentially ignoring Fannie and Freddie, which the government seized in September 2008. The budget that the Obama administration proposed this week included just one sentence on the future of the government-sponsored enterprises, saying the issue will be addressed at a time that is appropriate.
Warsh also said that giving regulators more power to resolve large, complex institutions does not go far enough. "If policymakers had gone into the crisis with the resolution authority to shut down nonbanks and complex bank holding companies quickly, we might well have had better options to ensure an orderly disposition of failing firms," he said. "Placing this arrow in our quiver now, however, is not enough to arm us for the challenges ahead."
What is needed, Warsh argued, is greater market discipline to complement tougher regulation.
"In order to resurrect market discipline from the ash heap of the recent crisis, stakeholders — that is, shareholders, creditors and regulators alike — need better, more timely information about financial firms," he said. "Asset quality and funding sources for financial firms must be more understandable and readily comparable among peers. Stakeholders can then make better-informed judgments of potential risks and rewards."
Warsh expressed hope that smaller institutions could take advantage of the stumbles by big banks during the crisis.
"The 'too big to fail' problem could be mitigated if smaller, dynamic firms seized market share from less nimble incumbents," he said. "The financial services industry is ripe for a healthy dose of creative destruction."
Warsh's comments came on the same day that Fed Chairman Ben Bernanke was formally sworn in for his second term at the helm of the central bank. His nomination was nearly derailed amid the uproar over the Fed's response to the financial crisis.
On Wednesday, Bernanke stood before several hundred staffers who gave him a standing ovation and acknowledged that the financial crisis humbled the central bank. "At the Federal Reserve and other agencies," he said, "the crisis revealed weaknesses and gaps in the regulation and supervision of financial institutions and financial markets."