The Fed's "Independence" Argument Is False

George Washington's picture

The House has passed a bill to audit the Federal Reserve. 79% of the American people support a full audit.

In response, the Fed says that an audit would interfere with its "independence".

However,
the Constitution does not empower a central bank, and Congress - which
created the Federal Reserve in 1913 and which has the power to create
credit and money - certainly has the power to audit, dissolve, or do
whatever it likes with the central bank (including stripping it of the power to create credit).

I have previously pointed out that the the independence argument is a red herring.

And I have previously demonstrated that the Fed has done a terrible job of managing the economy, keeping unemployment low, and regulating banks.

Now,
in an interview this weekend with Der Spiegel, Paul Volcker - while
trying to support the Fed's argument for independence - actually undermines it:

SPIEGEL: Lawmakers on Capitol Hill are thinking about tougher controls over the Federal Reserve.

 

 

Volcker:
I think the loss of independence and authority of the Federal Reserve
would be a very serious matter for the United States. Not just in terms
of monetary policy but in terms of our place in the world. People look
to strong, credible institutions and I think the Federal Reserve has
been such an institution. If that's lost or too hamstrung by
legislation I think we will regret it.

 

SPIEGEL: But is
the Fed still the same kind of institution as during your tenure as
chairman? Or is it now more of a governmental instrument? The Fed is
managing the TARP program and is also buying government bonds.

 

Volcker:
In some sense the Federal Reserve is always an instrument of the
government. It is a government body but it is independent within
government. But you are right in the
sense that part of the concern is that they have involved themselves
quantitatively in entering markets and in that process, you are
supporting some markets and not others. That is an area in which the
Federal Reserve has never wanted to get into and one that most central
banks don't want to get into. If you are going to maintain your
independence you have to avoid that. To intervene in particular sectors
of the market is not the proper role for the central bank over time.
It could be justified only by extreme emergency.

Intervening and supporting some market players (Goldman, AIG, etc.) and not others (Lehman, etc.) is precisely what
Bernanke has been doing. Whatever can be said for the Fed in the past,
picking winners and losers is "not the proper role for the central
bank", in Volcker's words. Without an audit, we will never know which
"winners" were saved and which "losers" were left to die, or why.
Nor do we really currently know which bailouts and other actions were
truly performed under emergency conditions - to stave off catastrophe -
and which were done to help out financial companies for other reasons.

Moreover, Bernanke gave many billions to private foreign banks and foreign central banks (and see this). Has the Fed been picking winners and losers among countries? Among private banks?

As
former Federal Reserve economist William Bergman wrote (he sent me this
by email; it was previously published in article form, but is not
available on the Web):

 

One of the
principal laws governing audits in the Federal Reserve was passed in
1978, the Federal Banking Agency Audit Act. This law established audit
authority in the Comptroller General of the United States, who leads
today’s General Accountability Office (GAO). The GAO conducts audits
and surveys for a wide range of Federal Reserve activities, with over
100 conducted since 1978. Audit authority also resides in the Federal
Reserve Board’s Office of Inspector General, who can audit Board
programs as well as Reserve Bank operations when carrying out functions
delegated by the Board.

The Federal Reserve’s financial
statements are audited every year. The Board of Governor’s financial
statements are audited by an independent auditor selected by the
Board’s Office of Inspector General. The Reserve Banks’ statements are
also subjected to outside audits, conducted by firms retained by the
Board of Governors. These latter audits must have been an interesting
exercise this year, given the massive expansion in Reserve Bank balance
sheets in 2008. In turn, more generally, the Board of Governors
conducts a wide range of reviews of Reserve Bank operations as part of
its mandated oversight authority.

In this brief review of the
Fed audit landscape, it’s worth noting that things haven’t always been
this way. From the early 1930s to the early 1950s, for example, one of
the shoes was on the other foot, as audit teams from the Reserve Banks
examined the Board of Governors books. The GAO was actually precluded
by law, law passed by Congress, from audit responsibility for the Fed,
at least until the 1978 act referred to above. The main lesson here is
that the structure of reporting and audit authority has changed in the
past, and it can change again in the future.

But today, authority for auditing the Fed is in place. So why do so many people think we need an Audit the Fed Act?

Well,
for one thing, the appearance of extensive auditing authority doesn’t
mean audits are effective. Good auditing requires the willingness and
ability of auditors to do their jobs. Some people view the Inspectors
General, generally, and the Federal Reserve Board’s Office of Inspector
General, specifically, as less than effective or independent in
pursuing their mandates. In turn, some people question whether the
Board’s oversight of the Reserve Banks, including the Federal Reserve
Bank of New York, might be less than arms-length. More fundamentally,
from the point of view of the supporters of the recently introduced
legislation, there are a variety of restrictions on the ability of the
GAO to audit the Fed. There are significant exceptions for monetary
policy and transactions with foreign central banks and international
organizations like the Bank for International Settlements and the IMF.
The law proscribes GAO inspections of ‘deliberations, decisions, or
actions on monetary policy,’ for example, as well as ‘transactions made
under the direction of the Federal Open Market Committee.’ The proposed
legislation under H.R. 1207 and S. 604 would remove those exceptions.

Why are the exceptions there in the first place? Well, a
widespread mantra has it that Federal Reserve independence is crucial
in allowing it to effectively pursue the statutory goals of maximum
employment and stable prices.
If we let politicians start
mucking around in that arena too much, Fed leaders and supporters
stress, we aren’t going to see very effective monetary policy. At a
‘town hall’ meeting last weekend, while addressing the audit issue, Fed
Chairman Bernanke said ‘I don’t think people want Congress making
monetary policy.’ But these audit bills don’t call for the Congress to
make monetary policy. They call for broader authority for an
independent audit of the Fed, from the General Accountability Office.
Supporters feel it this authority would allow the Congress to do a
better job of overseeing the performance of an entity to which the
Congress has delegated the authority to ‘coin money, and regulate the
value thereof,’ under Article I of the U.S. Constitution.

How
independent is the Fed, right now, to begin with? The Fed is not an
apolitical beast. It has had politicians working there in formal
leadership positions as well as staffing roles. The Fed’s regulatory
performance matters for the conduct of monetary policy, and the Fed’s
relationships with the banks it regulates and bails out deserve
scrutiny. Recently, we’ve been through a financial calamity, and have
endured the biggest spike in the unemployment rate since World War II.
Investment returns crumbled in 2007 and 2008, and Federal Reserve
monetary and other regulatory policy played a significant role in this
calamity. Looking back a little further, how effective has the
‘independent’ Fed been as source of stable prices? Congress passed the
law first mandating ‘stable prices’ as a goal for Fed monetary policy
in 1977, and the CPI has tripled since then.

The debate over
curtailing the current legal restriction on GAO audits for
‘transactions made under the direction of the Federal Open Market
Committee’ makes for a good case in point. This provision, on the
surface, helps insulate monetary policy from Congressional oversight
and/or second-guessing, promoting independent policymaking. But the FOMC conducts monetary policy under authority delegated by the Congress.
It seems reasonable to allow for some form of stronger inquiry in this
area, especially after the worst financial and economic crisis since
the Great Depression. One facet of a possible future investigation
could deal with individual monetary policy ‘transactions.’ Under the
quantitative easing posture adopted by the Fed in recent years, with a
wider range of financial instruments bought to liquify the banking
system and promote monetary and credit growth, the question arises – at
what price were those instruments bought? Were they ‘market’ prices, or
were they another way to apply public resources to overpay for bad
assets and help large financial firms that got into trouble?

That
may or may not be a valid avenue of inquiry, but it seems like we could
benefit greatly from learning about the broader range of issues that
could be tackled.

Audit the Fed? Sounds good to me.