A single macro-prudential regulator should have responsibility for the stability for any national financial sector. This is the emerging consensus in the United States and in other industrial countries. The buck, so to speak, has to stop somewhere.
What should this regulatory agency do? One idea is that it should look after large complex institutions that have been designated systemically significant. Such institutions do need better supervision, and concentrating the talent needed to supervise them better in a single place makes sense. But if a separate regulator does this, it will have a strong interest in perpetuating these institutions forever--a bad and in fact an impossible idea. Moreover, large numbers of institutions and markets would lie beyond its purview where history tells us that many systemic crises, including the current one, start.
A second idea is that the Federal Reserve should be given greater oversight authority. This doesn't seem completely persuasive either. Chairmen vary in their commitment to regulation: the last one neglected to use Congressionally delegated authorities to oversee mortgage origination. Besides, it is an institution dominated by monetarists and neo-classicists: neither group is especially well-equipped to understand disequilibria in complex evolving systems. Finally, no more power needs to be concentrated in the Federal Reserve. Its balance sheet and monetary sovereignty confer power enough. Its chairman needs, and has, great independence to wield monetary authority effectively. There is no compelling reason to put more power over the detailed workings of the financial system in one pair of hands.
So what is the answer? It is to create a new macro-prudential agency. Let's call it a Federal Stability Board, or FSB for short--to make it clear that in many ways it should be on a par with the Federal Reserve, even if it was quite a small institution It should be tasked with "looking through" the existing institutional and functional regulators for signs of systemic risk exposure and tuning incentives of one kind and another to shepherd the sector away from systemic risk. This is like the existing President's Working Group on Financial Markets, except with a wider and deeper purview, independence from Treasury, and staying power.
The FSB needs to be able to incent comprehensive cooperation and coverage from the functional and institutional regulators. One way would be to fund the FSB from a statutory tithe of perhaps...