The Disappointing Office of Financial Research

Simon Johnson, former chief economist of the International Monetary Fund, is the Ronald A. Kurtz professor of entrepreneurship at the M.I.T. Sloan School of Management and co-author of “White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.”

One of the better ideas to surface during the early financial reform discussions was to create some form of national institute of finance, an independent body that could support outstanding research and help develop a broader understanding of lurking risks. In the Dodd-Frank Act of 2010, largely through the efforts of Senators Jack Reed, Democrat of Rhode Island (who introduced specific legislation),and Mark Warner, Democrat of Virginia, this became the Office of Financial Research.

Unfortunately, while the office had well-intentioned parents, it was also cursed at birth by a modern Carabosse (the bad fairy who curses Sleeping Beauty). Timothy Geithner, then Treasury secretary, strongly opposed the creation of an independent body focused on diagnosis and assessment of systemic risks. Not being able to talk the Senate out of taking some action in this direction, Mr. Geithner fell back on a standard bureaucratic trick - he took the Office of Financial Research into the Treasury and set about ensuring that it would never be particularly effective.

Four years down the road, it looks as though Mr. Geithner largely got his way. It would take a sweeping change and perhaps new leadership for the vision of Senators Reed and Warner to become something close to reality.

There are many excuses offered for the Office of Financial Research’s lackluster results. It is still hiring (as reflected in a recent report to Congress), its mandate overlaps those of other agencies (the Federal Reserve and the Securities and Exchange Commission have proved hard to work with), and the analytical problems are daunting.

All this may be true, but it does not fully explain why the office’s reports make, at best, for such uninteresting reading. And based on the testimony Wednesday by its director, Richard Berner, to the economic policy subcommittee of the Senate Banking Committee, its briefings to Congress are unlikely to prove any more informative.

In the view of the subcommittee’s chairman, Senator Jeff Merkley, Democrat of Oregon, a clear lesson from the financial crisis is “that we need to do a much better job of identifying and addressing systemic risk before it’s too late.” But the hearing did not provide any discernible improvement along those lines.

Mr. Geithner’s perspective on financial system surveillance seems to have been shaped largely by his time as president of the Federal Reserve Bank of New York, although his previous experience at the International Monetary Fund and Treasury may have played a role.

In this approach, officials largely defend existing practices of the financial sector and provide generous support when important firms need assistance. The board of the New York Fed, for example, has long represented the financial elite of that city. Jamie Dimon, the chief executive of JPMorgan Chase, was a member of that board in early 2008 - and declined to resign, even though the Fed helped his company buy Bear Stearns. Quite why the Federal Reserve’s Board of Governors did not suggest or force his resignation, to avoid the appearance of any conflict of interest, remains a puzzle.

The Office of Financial Research could have been set up to be more independent of Treasury - and this was part of the original intent. It has an independent budget, but appears to operate very much under Treasury’s wing.

Compare this with the Office of the Comptroller of the Currency, which is also nominally within Treasury but which has been much more independent - and, under its current director, Thomas J. Curry, much more effective.

The Office of Financial Research is not a complete loss. For example, among its research papers is some sound work by Rick Bookstaber and others. (Mr. Bookstaber’s book on the financial crisis, “A Demon of Our Own Design: Markets, Hedge Funds and the Perils of Financial Innovation,” written before he joined the office, deserves to be widely read.)

But the office’s data page provides details on just one initiative, and I don’t find much more of substance in its agenda (a sampling of which is provided by their news and events page as well as elsewhere on its website). The 2013 annual report was not impressive; it read like some of the less informative systemic risk assessments that we saw prior to 2007.

And the office’s most high-profile product was its report on asset management, about which Dennis Kelleher of Better Markets had this to say in a blistering comment letter:

It appears to confirm some of the worst suspicions that O.F.R. is influenced by and biased toward the too big-to-fail sell-side banks that dominate Wall Street. After all, rather than focusing on the known systemic risks that they pose, which materialized just five years ago and which inflicted widespread economic wreckage across the country, O.F.R. chooses to take aim at the asset management buy-side of the financial industry, which, by comparison, presents much lower risk and played no role or virtually no role in the most recent financial crash.

It is all very disappointing, particularly given that the office’s annual budget is running at a remarkable $86 million (see Page 119 of the 2013 report).

There is much more that the Office of Financial Research could do, including - just as one example - Eric A. Posner and E. Glen Weyl’s idea of establishing a form of Food and Drug Administration for complex financial products. It is currently far too easy to create financial products that have toxic systemic side effects. We used to allow such unregulated innovation for pharmaceutical products but learned the very hard way that this is not in the social interest.

Over all, the Office of Financial Research is very disappointing. Mr. Berner can and should turn this important agency around.