Saturday, December 07, 2013

NY Fed Official Says Financial Stability Part of Central Bank’s Mandate

In one of the most thought-provoking comments of the year, a NY Fed official, citing the penumbra doctrine advanced by Justice William O. Douglas in the Griswold case,  said that financial stability should be part of the Fed’s mandate in addition to price stability and maximizing employment.

Citing Justice Douglas, N.Y. Fed Executive Vice President and General Counsel Thomas Baxter found a third mandate to promote financial stability in a penumbra to the Federal Reserve Act and in express provisions in the Dodd-Frank Act. In remarks at recent E.U. conference, he noted that the legal basis for deriving implied powers from the penumbra of other express powers is best seen in the opinion of Justice Douglas in Griswold v. Connecticut, where he reasoned that the First Amendment has a penumbra where privacy is protected from governmental intrusion, in particular the right of association. 

Similarly, the Federal Reserve Act has a penumbra where the Federal Reserve derives its mandate to ensure financial stability, such that it may achieve the Section 2A dual mandate of price stability and maximum employment.  The key point here is that the Federal Reserve’s financial stability mandate is derived from what lies in the penumbra, reasoned the Fed official, not from any express reference to financial stability in the Federal Reserve Act itself. 

And, financial stability is an open and obvious topic of Title 1 of the Dodd-Frank Act, whose most consequential provisions is Section 165, which empowers the Board of Governors to develop enhanced prudential standards for systemically important financial institutions.  In a provision directly affecting central bank powers, Congress instructs the Federal Reserve to develop prudential standards to prevent or mitigate risks to financial stability  that could arise from the material financial distress or failure, or ongoing activities, of large interconnected financial institutions.

There are other provisions of the Dodd-Frank Act granting new powers to the Federal Reserve with respect to financial stability, noted the NY Fed official. One obvious provision is Section 604, which amends the Bank Holding Company Act to direct the Federal Reserve to consider, when it evaluates an application for approval of a proposed acquisition, merger, or consolidation, whether it would result in greater or more concentrated risks to the stability of the United States banking or financial system.

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