The fact that the Fed needed to take those actions provides a stark illustration of the significant gaps in our regulatory structure, gaps that must be eliminated. Among those holes was the absence of effective consolidated oversight of certain large and deeply interconnected firms; the collective failure of regulators – including the Federal Reserve – to appreciate the linkages and amplification mechanisms embedded in our financial system; and the absence of a resolution process that would allow even the largest and most complex of financial institutions to fail without imperiling the flow of credit to the economy more broadly. Addressing these shortcomings will require important reforms in our country’s regulatory architecture. We entered the crisis with an obsolete regulatory system. For one, our regulatory system was not structured for a world in which an increasingly large amount of credit intermediation was occurring in nonbank financial institutions. As a result, little attention was paid to the systemic implications of the actions of a large number of increasingly important financial institutions – including securities firms, insurance conglomerates and monolines. In addition, many large financial organizations were funding themselves through market-based mechanisms such as tri-party repo. This made the system as a whole much more fragile and vulnerable to runs when confidence faltered. With the benefit of hindsight, it is clear that the Fed and other regulators, here and abroad, did not sufficiently understand the importance of some of these changes in our financial system.

A dispassionate analysis of what is needed will almost certainly lead to better decisions and a more effective regulatory framework. The legislative proposals concerning the Federal Reserve are not limited to the Federal Reserve’s role in supervision. Consider, for example, one proposal that calls for what it terms “audits” of the Federal Reserve by the U.S. Government Accountability Office (GAO), an arm of Congress. These wouldn’t be audits at all in the commonly understood sense of the term. The Federal Reserve’s financial books and transactions are already audited by wide range of professionals internal and external to the institution. Rather, these new audits would involve ex-post review of Federal Reserve monetary policy decisions, a potential first step toward the politicization of a process that Congress has carefully sought to insulate from political pressures. The notion that the Federal Reserve’s financial dealings are somehow kept hidden from the public is a surprisingly widely held view – and it is simply incorrect. An independent outside audit of the Federal Reserve’s books is conducted annually. You can find the results online, including a detailed accounting of the Federal Reserve’s income and operating expenses in its annual report. The financial books of the regional Federal Reserve Banks also undergo independent outside audits, also available online. In addition, the GAO is empowered to review almost all Federal Reserve activities other than the conduct of monetary policy, including the Federal Reserve’s financial operations, which the GAO has done so frequently.