OFR Will Do Better Work If the Treasury Isn't Its Boss

Now that the GOP has more clout on Capitol Hill, it's a pretty easy bet that the Dodd-Frank Act will get a second look next year.

No one is expecting huge changes, but Congress should free the Office of Financial Research from the Treasury Department.

Created by Dodd-Frank, the office is fundamentally a great idea, but it should be carved out of the Treasury and operated as an independent agency.

That is the best way to ensure the OFR will be able to do its job and spot the next financial crisis early enough to make a difference.

If the OFR becomes widely recognized as adept at spotting brewing problems, it could provide much-needed muscle to the banking agencies when they try to curb a risky practice or product.

If the office said an asset bubble was forming and lenders should beware, or if it identified a product that was growing like kudzu, it also would be much harder for lawmakers to meddle.

Think of this office as a levee protecting regulators and holding politicians at bay.

Former Comptroller of the Currency Eugene A. Ludwig drew another analogy, evoking the prophet Jeremiah.

"The Office of Financial Research needs to be independent. It needs to be able to function like a Jeremiah, warning regulators of emerging risks," said Ludwig, now the chief executive of Promontory Financial Group.

Under Dodd-Frank, the OFR is part of the Financial Stability Oversight Council, another creation of the law. The Oversight Council is a souped-up version of the Federal Financial Institutions Examination Council with 15 members representing an array of federal and state supervisors. The oversight council, which is chaired by the Treasury secretary, plans to hold its second meeting on Nov. 23; headlines from its first meeting mainly focused on predictable conflicts among its many members.

The OFR is to have its own director, appointed by the president to a six-year term and subject to Senate confirmation. But President Obama has yet to nominate anyone to the post. In the interim, Treasury staff is trying to get the office off the ground.

In a nutshell, the OFR's job is to spot the next financial crisis before it is too late.

To do this, the office will figure out what data it needs and then how to standardize the reporting of that data. It will be able to force reporting from any financial company but its focus will be those firms deemed by the Oversight Council to be "systemically important." (It's unclear how wide this net will be cast, but at a minimum that's every banking company with more than $50 billion in assets.) The office will have the authority to subpoena information from any firm that balks at its requests.

In addition to a Data Center, the office will have a Research and Analysis Center to analyze the data and conduct research into emerging risks. This unit also will "evaluate and report on stress tests or other stability-related evaluations of financial entities overseen by the member agencies," according to the law.

While Dodd-Frank does not get superspecific on the types of data the OFR will collect, it does cite both transaction and position data.

According to an analysis of the law by Davis Polk, transaction data includes the "structure and legal description of a financial contract, with sufficient detail to describe the rights and obligations between counterparties and make possible an independent valuation."

Position data, Davis Polk says, includes "data on financial assets or liabilities held on the balance sheet of a financial company and includes information that identifies counterparties, the valuation by the financial company of the position, and information that makes possible an independent valuation of the position."

Just how protected this information will be is unclear. The office is subject to the Freedom of Information Act, but it will also be able to redact proprietary information.

Finally, Dodd-Frank envisions that the OFR will "promote best practices for financial risk management."

Sounds like a big job with a lot of authority, but in so many places the new law notes that the OFR can do X only "after consultation with the Treasury secretary."

That is a mistake. The Treasury secretary is a member of the president's cabinet who is expected to advance the administration's priorities. Say the OFR wants to put the brakes on some financial product or practice and the administration objects because doing so might slow economic growth. Who is likely to win that debate?

Dodd-Frank did put the OFR director on the oversight council, but only as a nonvoting member. And the law makes a nod in the direction of independence by mandating that the OFR director testify before Congress every year and specifically noting that no other government official may review the testimony. (This testimony, detailing the threats to financial stability, will not begin until mid-2012.)

For its first two years, the OFR will be funded by the Federal Reserve. After that, the office will assess a fee on all banking companies with more than $50 billion in assets and any nonbanks or foreign banks that the oversight council deems "systemically important."

Treasury spokesman Steve Adamske on Wednesday said the department has no estimate for either the size of the office's staff or budget. A team of officials, led by Deputy Secretary Neal Wolin, is setting up the OFR, he said.

Adamske said he did not know when the administration would nominate the office's director.

If the government is serious about getting ahead of the next crisis, that appointment should come quickly. It should be someone with the experience and clout to command respect.

Rumored candidates include Laura Tyson, the chairman of President Clinton's Council of Economic Advisers who is now teaching at the University of California, Berkeley; John Geanakoplos, a Yale economics professor who is also a partner at the hedge fund Ellington Capital Management; and Allan Mendelowitz, a former member of the Federal Housing Finance Board and an early proponent of the National Institute of Finance, on which the OFR is based.

Andrew Lo, director of the Laboratory for Financial Engineering at the MIT Sloan School of Management, said independence for the office "was a nonstarter" when Dodd-Frank was being written.

"People fought that tooth and nail because they didn't want an independent agency digging up dirt and pointing fingers at current and former policymakers that would be potentially embarrassing," said Lo, who followed the office's creation closely.

Still, Lo offers a hopeful example in the National Transportation Safety Board. The independent agency was split off from the Transportation Department in 1974 after policymakers realized it needed to be free of political influences.

The OFR "should be a separate and independent agency," Lo said. "But this is a starting point, not an ending point."


Correction to last week's column: Dodd-Frank does in fact supply new tools to stop products or practices while they are still going gangbusters. Under the law, the FSOC may recommend that the regulatory agencies "apply new or heightened standards and safeguards … for a financial activity or practice … if the council determines that the conduct, scope, nature, size, scale, concentration or interconnectedness of such activity or practice could create or increase the risk of significant liquidity, credit, or other problems spreading among bank holding companies and nonbank financial companies, financial markets of the United States, or low-income, minority, or underserved communities." I stand corrected and thank Karen Shaw Petrou of Federal Financial Analytics for pointing out my error.

Barb Rehm is American Banker's editor at large. She welcomes feedback to her weekly column at Barbara.Rehm@SourceMedia.com

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