One of the central tenants of central bank politics is that these venerable institutions must be insulated from political influence and intimidation. It was not so long ago that the obscure and enigmatic central banker was considered the most adept. The "independence" of central banks is intended partly to service their unenviable burdens. In particular, the need to put the breaks on the economy here and there- a decidedly unpopular mandate politically, indeed, one that can topple administrations. Further, to resist the many calls to spur short-term growth (paid back with interest in later years) via monetary policy. In this context, and given the recent calls for total transparency (read: total political accountability) of the Federal Reserve System how is one to look at "The Great Moderation?" In the case of this article, as an opportunity to offer a pair of novel and contrarian theories:
1. It was the presence of political accountability in monetary policy, not its absence that sewed the seeds of the present crisis.
2. The natural conclusion can only be that Monetary Policy Institutions require less political accountability, not more.
To begin with, it will be useful to be particular about what is meant by "Monetary Policy Institutions." Obviously, central banks officially charged with the management of monetary policy apply. Officially, (that is, according to the Federal Reserve Act) the goal of monetary policy is to:
...maintain long run growth of the monetary and credit aggregates commensurate with the economy's long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates. (12 USC § 225(a))
Conventional wisdom would hold this role as one limited to the Federal Reserve System- since that's what the Federal Reserve Act says. Practically speaking, the Federal Reserve System is merely one of several Monetary Policy Institutions in the United States- that is, institutions with the ability and the indirect (if not direct) mandate to influence prices, employment and long-term interest rates on a large scale.
Some introductory facts:
In 2008 some $6 trillion in interest bearing, marketable public debt issued by the Treasury was outstanding. Nearly $9 trillion in "Mortgage Related" debt was floating about at the same time. Of this, some $5 trillion was either securitized or guaranteed by Government Sponsored Entities ("GSEs") like Fannie Mae and Freddie Mac or other government entities. The Federal Reserve's balance sheet today, near its most bloated state, sits at a mere $2.1 trillion, and this is more than double its size before the recent, world-saving expansion.
True, GSEs and other mortgage related entities do not have the Discount Window as a tool to influence rates. But given their central role in setting mortgage rates for the country (an $8 trillion dollar economic experiment) and the ability to permit market actors to offload risk to them with impunity, it is difficult not to regard these institutions as powerful monetary policy tools, tools that have been used shamelessly since the 1980s to artificially push mortgage rates below their equilibrium state even given an already loose monetary policy pursued by crisis pariah Alan Greenspan. Recognizing the "multi-tiered" nature of monetary policy is critical to understanding both the current crisis, and the nature of the problem.
Put simply: Not content with permitting the Federal Reserve System to run monetary policy, that is, believing that, in its wisdom, it knew better what mortgage rates should look like, Congress, with the acquiescence of a number of successive executive administrations, elected to usurp a wide swath of monetary policy for itself via mortgage lending. The result: Real estate became joe-sixpack's bank, 401(k) portfolio, job creation machine, unemployment check, and, finally, lender of last resort.
It is easy to forget that during Greenspan's tenure, Congress often chided (even outright savaged) the Chairman for not doing enough to spur levels of economic growth they thought appropriate. In hindsight this is illustrative of the concept that the "green is always greener on the other side" (of monetary policy) even during boom times.
Greenspan's contemporary bemusement that he might be blamed for the crisis given his belief that "short term" rates shouldn't influence mortgages fell on deaf ears- but probably shouldn't have. The reality is that through a series of political lackeys appointed based on the merits of their political acumen and either totally out of their depth or at the end of their careers, the GSEs effectuated rampantly loose monetary policy for years, totally unopposed by Democrats (who were graciously ushered into office by the millions of beneficiaries of glossy "low-income loans," "first time buyer" incentives and the like) or Republicans (who were lulled into hypnotic trances by prose containing the phrase "The American Dream of Home Ownership.")
It is precisely because the political system creates such bi-partisian perfect storms that monetary policy should never be given over to populists. Since this author is hard-pressed to named a non-populist in Congress today, turning over the Federal Reserve System to legislative whims suggests a quick repeat of the same crisis writ large(r). The Federal Reserve System must have the stamina and testicular fortitude to stand firm in the face of crisis and embrace bank failure and rebirth. Letting Lehman go, far from a sin, was quite saintly. What followed, a total acquiescence to political cries to "do something for the love of all things capitalist," was the beginning of the end. Oh no! The country will not permit that sort of thing again!
While auditing the Federal Reserve System may go a long way toward exposing the dangers of the institution and the excesses of years past, there is a real danger that subjecting it to scrutiny in future years will make monetary policy even more a political animal than it is today. One wonders, even as the Federal Housing Administration teeters towards collapse, how the many adjuncts and aides-de-camp to the GSEs have managed to avoid similar scrutiny given their central role in the crisis.