Should We Give the Fed More Power ... Or Less?

George Washington's picture

Washington's Blog.

Congress
is suggesting that the Fed be given more powers, making it the chief risk
regulator of the entire banking system.

Specifically, as summarized
by Huffington Post, a new bill introduced by Democrats in Congress
"gives the Federal Reserve the power to determine which firms are
actually 'too big to fail' and pose systemic risk to the financial
system."

Given the Fed's history  (as discussed below), that is like appointing the head of the Medellin drug cartel as drug tzar. 

Admittedly,
the Congressional bill allows other agencies a seat at the risk
regulator table. But those are likely token seats. If the drug tzar's
office was staffed by the head of the Medellin drug cartel - who had
the majority vote - and some law enforcement officers who have a
history of either (a) being on the take or (b) looking the other way,
what do you think would the result would be?

High-Level Fed Officials Speak Out

High-level
officials of the Fed itself have criticized the Fed's actions. For
example, the head of the Federal Reserve bank of San Francisco - during
a talk on how runaway bubbles can lead to depressions - admitted:

Fed monetary policy may also have contributed to the U.S. credit boom and the associated house price bubble ...

Fed Vice Chairman Donald Kohn conceded
that the government's actions "will reduce [companies'] incentive to be
careful in the future." In other words, he's admitting that the
government's actions will encourage financial companies to make even riskier gambles in the future.

Kansas City Fed President and veteran Fed official Thomas Hoenig said:

Too big has failed....

The
sequence of [the government's] actions, unfortunately, has added to
market uncertainty. Investors are understandably watching to see which
institutions will receive public money and survive as wards of the
state...

Any financial crisis leaves a stream of losses among
the various participants, and these losses must ultimately be borne by
someone. To start the resolution process, management responsible for
the problems must be replaced and the losses identified and taken. Until
these actions are taken, there is little chance to restore market
confidence and get credit markets flowing. It is not a question of
avoiding these losses, but one of how soon we will take them and get on
to the process of recovery
....

Many
of the [government's current policy revolves around the idea of] "too
big to fail" .... History, however, may show us a different experience
.
When examining previous financial crises, both in other countries as
well as the United States, large institutions have been allowed to
fail. Banking authorities have been successful in placing new and more
responsible managers and directions in charge and then reprivatizing
them. There is also evidence
suggesting that countries that have tried to avoid taking such steps
have been much slower to recover, and the ultimate cost to taxpayers
has been larger
...

The current head of the Philadelphia fed bank, Charles Plosser, disagrees with Bernanke's strategy of the endless printing-press and ever-increasing fed balance sheet:

Plosser
urged the Fed to "proceed with caution" with the new policy. Others
outside the Fed are much more strident and want plans in place
immediately to reverse it. They believe an inflation storm is already
in train.***

Bernanke
argued that focusing on the size of the balance sheet misses the point,
arguing the Fed's various asset purchase programs are not easily
summarized in a single number.

But Plosser said that the growth of the Fed's balance sheet was a key metric.
"It is not appropriate to ignore quantitative metrics in this new policy environment," Plosser said.***

Plosser is bringing the spotlight right back to the Fed's balance sheet.

"The size of the balance sheet does offer a possible nominal anchor for
monitoring the volume of our liquidity provisions," Plosser said.

The
former head of the Fed's Open Market Operations says the bailout might
make things worse. Specifically, the former head of the Fed's open
market operation - the key Fed agency which has been loaning hundreds
of billions of dollars to Wall Street companies and banks - was quoted in Bloomberg as saying:

"Every
time you tinker with this delicate system even small changes can create
big ripples,'' said Dino Kos, former head of the New York Fed's
open-market operations . . . "This is the impossible situation they are
in. The risks are that the government's $700 billion purchase of assets disturbs markets even more.''

And William Poole, who recently left his post as president of the St. Louis Fed, is essentially calling Bernanke a communist:

Poole said he was very concerned that the Fed could simply lend money to anyone, without constraint.
In the Soviet Union and Eastern Europe during the Cold War era,
economies were inefficient because they had a soft-budget constraint.
If a firm got into trouble, the banking system would give them more
money, Poole said.
The current situation at the Fed seems eerily similar, he said.

"What is discipline - where are the hard choices - when does Fed say our resources are exhausted?" Poole asked.

But
the strongest criticism may be from the former Vice President of Dallas
Federal Reserve, who said that the failure of the government to provide
more information about the bailout could signal corruption. As ABC writes:

Gerald
O'Driscoll, a former vice president at the Federal Reserve Bank of
Dallas and a senior fellow at the Cato Institute, a libertarian think
tank, said he worried that the failure of the government to provide
more information about its rescue spending could signal corruption.

"Nontransparency
in government programs is always associated with corruption in other
countries, so I don't see why it wouldn't be here," he said.

Of course, former Fed chairman Paul Volcker has also strongly criticized current Fed policies.

Global Agencies Speak Out

BIS - the central banks' central bank - slammed
the Fed and other central banks for blowing bubbles and then "using
gimmicks and palliatives" which "will only make things worse".

The head of the World Bank also says:

Central
banks [including the Fed] failed to address risks building in the new
economy. They seemingly mastered product price inflation in the 1980s,
but most decided that asset price bubbles were difficult to identify and to restrain with monetary policy. They argued that damage to the 'real economy' of jobs, production, savings, and consumption could be contained once bubbles burst, through aggressive easing of interest rates. They turned out to be wrong.

Economists Speak Out

Stephen
Roach (former chief economist for Morgan Stanley, and now director of
Morgan Stanley Asia) is one of the most influential and respected
American economists.

Roach told Charlie Rose this week that we
have had terrible Federal Reserve policy for the past 12 years under
Greenspan and Bernanke, that they concocted hair-brained theories (for
example, that we should let the boom and bust cycle occur, but then
"clean up the mess" once things fall apart), and that we really need to
reform the Fed.

Specifically, here's the must-read portion of the interview:

STEPHEN
ROACH: And what’s missing in the debate that drives me nuts is going
back to the very function of central banking that’s at the core of our
financial system. Do we have the right model for the Fed to go forward?
And, you know, I think we’ve minimized the role that the custodians,
the stewards of our financial
system, the Federal Reserve, played in
leading to this crisis and in making sure that we will never have this
again. I think we’ve had horrible central banking in the United States
for the past dozen of years. I mean, we elevate our central bankers, we
probably .

CHARLIE ROSE: From Greenspan to Bernanke.

STEPHEN ROACH: Yeah.

CHARLIE ROSE: Both.

STEPHEN ROACH: We call them maestro, and, you know, we make them
sound larger than life. And, you know, and the fact is, they condoned
policies that took us from one bubble to another. They failed to live up
to their regulatory responsibility granted them by law. They concocted new
theories to explain why these things could go on forever, and they harbored
the belief, mistakenly in my view, that monetary policy is too big and
blunt an instrument, and so you just bring it in to clean up the mess
afterwards rather than prevent a mess ahead of time. Well, look at the
mess we’re in right now. We need a different approach here. We really do.

Leading economist Anna Schwartz, co-author of the leading book on the Great Depression with Milton Friedman, told
the Wall Street journal that the Fed's entire strategy in dealing with
the financial crisis is wrong. Specifically, the Fed is treating it as
a liquidity problem, when it is really an insolvency crisis.

Moreover, prominent Wall Street economist Henry Kaufman says that the Federal Reserve is primarily to blame for the financial crisis:

"I
am convinced that the misbehavior of some would have been much rarer --
and far less damaging to our economy -- if the Federal Reserve and, to
a lesser extent, other supervisory authorities, had measured up to
their responsibilities ...

 

Kaufman directly criticized former
Federal Reserve Chairman Alan Greenspan for not using his position to
dissuade big banks and others from taking big risks.

 

"Alan
Greenspan spoke about irrational exuberance only as a theoretical
concept, not as a warning to the market to curb excessive behavior,"
Kaufman said. "It is difficult to believe that recourse to moral
suasion by a Fed chairman would be ineffective."

 

Partly
because the Fed did not strongly oppose the repeal in 1999 of the
Depression-era Glass-Steagall Act, more large financial conglomerates
that were "too big to fail" have formed, Kaufman said, citing a factor
that has made the global credit crisis especially acute.

 

"Financial
conglomerates have become more and more opaque, especially about their
massive off-balance-sheet activities," he said. "The Fed failed to rein
in the problem."...

 

"Much of the recent extreme financial
behavior is rooted in faulty monetary policies," he said. "Poor
policies encourage excessive risk taking."

Economist Marc Faber says
that central bankers are money printers who create bubbles, and that
the system would be much better now if the Fed hadn't intervened.
Specifically, Faber says that - if the Fed hadn't intervened - the
system would be cleaned out, the system would be healthier because debt
load and burden on taxpayers would be reduced.

Economist Jane D'Arista has shown
that the Fed has failed miserably at its main task: providing a
"counter-cyclical" influence (that is, taking the punch bowl away
before the party gets too wild).

The Fed has also failed miserably in its role as regulator of banks and their affiliates. As well-known economist James Galbraith says:

The
Federal Reserve has never been an effective regulator for the
straightforward reason that it is dominated by economists and bankers
and not by dedicated skeptics who make bank regulation a full-time
profession.

The Fed has performed terribly in many other tasks as well.

And the Fed is unlawfully refusing to disclose to Congress or the American people who it's giving money to and what it is really doing.

Conclusion

Given
the above, isn't it obvious that Congress is attempting to give the Fed
more powers at a time when it should be audited, and then ended?