Minneapolis Fed President Gary H. Stern spoke at the American Enterprise Institute last week in favor of using the markets to help regulate banks -- an exercise roughly equivalent to preaching conservation to the Sierra Club.
But 10 years ago, when Mr. Stern and his colleagues at the Minneapolis Federal Reserve Bank first began suggesting that bank regulation could be made cheaper and more efficient by complementing it with market-based risk assessments, they had a harder time finding an interested audience.
Mr. Stern is philosophical about the time and energy he has spent promoting market discipline in papers and speeches over the past decade. "I view this as an investment," he said in an interview Friday. "Sometimes public policy works this way."
The investment may be paying off. These days, a wide range of people, from academics to Federal Reserve Board governors, are talking about market discipline as a good idea for supplementing bank regulation. "Supervisors have little choice but to try to rely more -- not less -- on market discipline augmented by more effective public disclosures to carry an increasing share of the oversight load," Fed Chairman Alan Greenspan said last month.
Fed Vice Chairman Roger W. Ferguson Jr. made similar comments last week, saying, "As banking organizations become more complex, we are going to need all the help we can get."
Mr. Stern agreed that added disclosure would be helpful, but said he is not convinced that regulators must mandate it.
"In fact, if we gave (the market) more incentive to care, we could see what additional information it would demand, and we could see what information large institutions might find it in their advantage, competitive or otherwise, to provide voluntarily," he said.
Mr. Stern has shifted his focus from trying to convince people that market discipline can work, to trying to find a way to implement it.
"We've gotten over the first hurdle: convincing people of its effectiveness," he said. "There are a lot of proposals out there. You have to look at what is most promising, and what you need to do to put it in place."
Last week Mr. Stern presented his own proposals for building market-generated signals into the regulatory regime for the country's largest banks.
The first step, he said, would be to generate "credible market signals of bank riskiness." He proposed requiring banks to issue subordinated debt or enter into reinsurance or co-insurance agreements.
The price investors or insurers would demand be a reliable indicator of a bank's soundness. Regulators could use these prices to gauge the need for supervisory action or to set a bank's federal deposit insurance premiums, he said.
Mr. Stern noted that questions remain about exactly how to determine when regulatory action would be triggered. Also, there are questions about how to account for the volatility inherent in the market. "Market returns can bounce around a lot depending on what's happening. The question is, how do you assess this data?"
But these are just details.
"The good news is that none of this is insurmountable," he said. "It's not rocket science -- it can be done."
