Alan Greenspan, who chaired the Federal Reserve for almost two decades, was the first person to testify at a hearing today before the Financial Crisis Inquiry Commission. In his testimony--which took up much of the morning--he vigorously defended the Fed against blame for the financial crisis.

When asked about the role of the Fed and the degree of fault that should fall on it, Greenspan responded with the defense that the first job of the central bank was setting monetary policy. "We had supervision and regulation as secondary but major issues," he told the panel. Third was monitoring systemic risk. He added that the Fed was structured accordingly to meet those mandates.

But when asked about risky subprime mortgages, Greenspan made further clarifications about the role of the Fed, drawing a distinction between supervision and enforcement. The Fed had concerns about subprime mortgage market and "a lot of that stuff was just plain fraud," he said, but the Fed had expressed its concerns, and other agencies--such as the SEC, which regulates securities, and the Department of Justice--could have followed up. Without an enforcement division like the SEC's, "the Federal Reserve is not an enforcement agency," he told the panel.

And yet the Federal Reserve Board's own guidelines about the central bank's purposes and functions do include powers of enforcement:

If necessary, the Federal Reserve may take formal enforcement actions to compel the management and directors of a troubled banking organization, or persons associated with it, to address the organization’s problems. For example, if an institution has significant deficiencies or fails to comply with an informal action, the Federal Reserve may enter into a written agreement with the troubled institution or may issue a cease-and-desist order against the institution or against an individual associated with the institution, such as an officer or director. The Federal Reserve may also assess a fine, remove an officer or director from office and permanently bar him or her from the banking industry, or both. All final enforcement orders issued by the Board and all written agreements executed by Reserve Banks are available to the public on the Board’s web site.

The SEC has taken a lot of heat on enforcement--especially for failing to take sufficient action against individual Wall Street executives. A closer examination of the Fed's own rules shows that it could have also, but did not focus on enforcement--something to consider as the Fed continues to argue for preservation of its broad supervisory powers.

In his testimony, Greenspan also reiterated his view that adequate capital requirements are the single most important measure in protecting against another crisis.

"If we had adequate capital and liquidity, whatever else we do would be helpful but not critical," he said. "If we had everything else but not adequate capital and liquidity, the system will fail to function." Given that the Fed currently has the power to influence leverage constraints on banks and bank holding companies--and had those powers when Greenspan was chairman--his sudden insistence on their importance is somewhat belated.

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