Discussion of Bank of England's authority highlights need for guarding the guardians

It has taken five years since the beginning of the financial crisis, but the conversation has finally turned to the issue of 'who guards the guardians' of the financial system and what sort of authority should they actually be given.

As reported by the Guardian, former Monetary Policy Committee member Kate Parker observed

Treasury plans to hand the Bank of England extra powers to oversee the banking system will give unelected officials too much power... the steady erosion of democratic control over regulation of the financial system would accelerate under proposals by the coalition government to create a super-watchdog in Threadneedle Street.

She said oversight should be the job of the Treasury, based on advice from the Bank of England and other bodies involved in banking regulation. 

Echoing fears among many MPs that Bank of England governor Sir Mervyn King and his successors will control an unwieldy empire of regulatory committees that could challenge the Treasury's democratic mandate, Barker criticised government plans to create a financial policy committee (FPC) alongside the Bank's monetary policy committee (MPC), which sets interest rates. 

"More policy decisions should be left in the hands of the chancellor, rather than unelected officials at the Bank of England. Mervyn King's successor will be appointed to an unduly powerful role for an unprecedented eight-year term," she said. 

The FPC differs from the work previously carried out at the Financial Services Authority because it aims to "assess and steer the financial system as a whole, rather than focusing on individual organisations, which will now become the responsibility of the Prudential Regulatory Authority", she says. For example, FPC members will have the power to restrict mortgage lending if there are concerns about a possible credit bubble, as there was before the 2007 banking crisis. 

Barker criticises the Treasury for delegating unpopular decisions to the FPC that should be made by parliament.

This discussion of the authority of the Bank of England is not restricted to the UK.  It also applies in the EU where the ECB is seeking to gain bank supervision responsibility and the US where the Fed is responsible for bank supervision and also sits on the Financial Stability Oversight Council.

In his Telegraph column, Damian Reece seconds Kate Parker's conclusion.

Legislation is passing through Westminster that will usher in a new Bank Governor with too much power and not enough accountability. 

Sir Mervyn King, and his successor, may be called Governor but their job is not to govern. 

Barker’s report should prove useful to MPs trying to reverse some of the Chancellor’s plans which will delegate yet more authority to the Bank – authority which should stay within the remit of politicians. 

The problem is acute when it comes to macro-prudential regulation – basically controlling the economy’s safety valve to stop it overheating. It’s proposed this is done by yet another Bank of England committee – the Financial Policy Committee, which is every policy wonk’s fantasy come true....

In the US, macro-prudential regulations is the responsibility of the Fed and the Financial Stability Oversight Council.

The Financial Stability Oversight Council in not just every policy wonk's fantasy come true, but is also every Wall Street CEO's fantasy come true.  The Council is run by the US Treasury Secretary.

As thoroughly documented by Neil Barofsky in his book, Bailout, the US Treasury is an advocate for Wall Street's and not Main Street's interests.  As a result, through its control of the Financial Stability Oversight Council, Treasury is now able to push Wall Street's interests onto the very organizations that are suppose to be regulating Wall Street.

Outside of Washington DC, it is common sense that the Financial Stability Oversight Council is unfit for purpose of protecting the real economy.

Far from giving the Bank more power to run our economy, we should be insisting on No 11 taking that responsibility. The resident of that address is accountable to Parliament and removable every five years, rather than a Governor who changes every eight years and then by an opaque selection process.

Mr. Reece did not learn a key lesson from the Nyberg Report on the Irish banking crisis.  The key lesson is that elected officials have an incentive to not lean against the wind.  When the real estate bubble was growing, it generated lots of tax revenue that the elected officials could use on their favorite programs.  No elected official would want to cut the growth in tax revenue when there is no apparent danger.

On the other hand, Mr. Reece does understand that there is a problem anytime that there is opacity involved.

Opacity in selection process for the next Governor of the Bank of England means it is highly unlikely that this individual will have to document that they predicted the current financial crisis.  Without having predicted this crisis, it is highly unlikely this individual could predict a future crisis or develop policies that will get us out of the current crisis.

The solution to guarding the guardians is to bring transparency to all the opaque corners of the financial system.

If banks are required to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details, market participants can independently assess the risk of the banks and adjust the amount and price of their exposure accordingly.

The ability to independently assess what is going on means that market participants can exert discipline on both the banks and their regulators.

It also means that the collective result of having each market participant limiting their investments to what they can afford to lose is stability in the financial system.