Congress: Please get systemic risk solutions correct

Expected overhaul of our nation’s financial system almost two years after it imploded rests in the hands of the full Senate. No doubt they will reshape the U.S. financial landscape.  Most important to U.S. investors and tax payers is that they must create mechanisms for early detection of financial time bombs. There must also be appropriate ways to defuse those systemic bombs before they become catastrophic. The independence of these mechanisms from political interference is critical to their long-term success.
 
Consistent with the recommendations of the Investors’ Working Group in June of 2009 (a bipartisan panel led by former SEC chairmen with the mission of injecting investor perspectives in the reform debate), CFA Institute has endorsed the creation of a technically astute, well-resourced, independent and apolitical body to oversee systemic risk. We advocated for a Systemic Risk Oversight Board that would be appointed by the president and accountable to Congress, but beholden to no existing regulatory structure.
 
Since those recommendations were issued, Washington’s approach has been unimaginative adherence to the current regulatory hierarchy accompanied by the usual jockeying for position by the Federal Reserve and U.S. Treasury. Investors’ calls for an independent systemic risk oversight structure that emphasizes technical prowess seemed for a time to have been overwhelmed by special interests.
 
As Congress takes up the final set of reform proposals, CFA Institute renews its strong support for provisions in the original bill reported out of the Senate Banking Committee for the creation of the Office of Financial Research (OFR). The OFR would engage in the kind of financial sleuthing that might have saved us from the disasters of the past years. There are several features investors think are vital in making systemic risk oversight functional, including analytical capability, the ability to hire competent experts, and the power and authority to investigate and research systemic risk wherever it resides in the financial system. Establishing the OFR in this manner would help ensure regulators have the right people and the right tools to go toe-to-toe with the firms they oversee, particularly in the areas of derivatives and other financially engineered products.
 
As a practical matter, CFA Institute remains deeply concerned about this all being strictly controlled within the Treasury Department. Placement and funding of the OFR within Treasury introduces the prospect of the entire systemic risk process being shaped and managed by the Treasury and the Administration, rather than being an enduring risk management utility that transcends the political priorities of the moment. In our view, taxpayers and investors should have more assurance that OFR will have full independence and that the Federal Reserve and Treasury will not proscribe or otherwise limit its investigative and recommendation efforts.
 
Budgetary and agenda-setting independence is essential if the OFR is to fulfill its potential and function in the full spirit of its mandate. Consider the lessons learned from the National Transportation Safety Board, which was established under the umbrella of the Department of Transportation but became truly independent some eight years after its founding. Congress recognized, albeit belatedly, that to fulfill its apolitical investigative mandate, the NTSB had to be free of its parent agency’s agendas.
 
Establishing an independent research and assessment function for systemic risk issues can also go a long way toward addressing the problems of inter-agency communication. One clear lesson from the financial crisis is the peril of regulatory silos that restrict an overarching view of the financial system and its components. An independent, nonpartisan OFR would be well situated to aggregate and synthesize intelligence gathered throughout the regulatory apparatus, without being burdened by political calculations about what information to share with whom. Resolving issues would remain with the appropriate regulators, but diagnosis of emerging problems would benefit from a comprehensive and independent perspective and expert analysis.
 
As regulatory reform hits the home stretch, Senate and House leaders must grasp the opportunity to fully establish and strengthen the autonomy of the OFR.  Much is at stake here.  We would be naive to underestimate the bureaucratic turf in peril or the commercial interests at the table. Resistance from industry interests will be strong.
 
Ultimately, the stakes come down to vigilance against a repeat of the financial disasters just concluded, not to mention the pressing need to renew confidence in financial regulators.  A wiser, longer view on the part of existing regulators and industry would acknowledge these needs. We are long overdue for unbiased and effective systemic risk oversight.
 
Kurt Schacht, JD, CFA, is Managing Director, Standards and Financial Market Integrity division of CFA Institute.  James Allen, CFA, is Capital Markets Policy Head of CFA Institute.