Tag: Federal Reserve

What Fed Independence?

More than 250 economists have signed an “Open Letter to Congress and the Executive Branch” calling upon them to “defend the independence of the Federal Reserve System as a foundation of U.S. economic stability.”

Allan Meltzer is not a signatory to the petition and he has explained why not.  The Fed has frequently not shown independence in the past, and there is no reason to expect it to do so reliably in the future.  Professor Meltzer has just completed a multi-volume history of the Fed and knows all-too-well of the Fed’s willingness to accommodate the policies of administrations from FDRs to Lyndon Johnson’s. 

I would add that the Fed’s behavior under Chairman Bernanke breaks new ground in aligning the central bank’s policy with Treasury’s.  Much of what the Fed has done, first under Bush/Paulson, and now under Obama/Geithner, involves credit allocation.  Since that ultimately involves the provision of public money for private purpose, it is pre-eminently fiscal policy.  Central bank independence is a fuzzy concept.  If it means anything, however, it is that monetary policy is conducted independently of Treasury’s fiscal policy.

In short, it is not the critics of the Fed who threaten its independence, but the Fed’s own actions.  Its intervention in the economy is unprecedented in size and scope. It is inevitable that those actions would lead to calls for further Congressional oversight and control.  The Fed is a creature of Congress and ultimately answerable to that body. 

The petition raises legitimate concerns about whether the Fed will be able to tighten monetary policy when the time comes, and exit from its interventions in credit markets.  But it is precisely the Fed’s own recent actions that raise those problems.  Critics of recent Fed policy actions have for some time complained that the Fed has no exit strategy.  Apparently the critics are now going to be blamed for the Fed’s inability to extricate itself from its interventions.

Cross-posted at ThinkMarkets

Bernanke’s Part in the Housing Bubble

bernankeRecent weeks have seen a swirl of speculation over whether President Obama will or will not re-appoint Ben Bernanke to the Chairmanship of the Federal Reserve Board, when his current term as Chair expires in January 2010. Almost all of the debate has centered on his actions as Chairman. This narrow focus misses an important piece: his actions, and words, as a Fed governor during the build-up of the housing bubble.

What should have been Bernanke’s greatest strength as a Fed governor and later chair, his understanding of monetary theory and his knowledge of the Great Depression, has ended up being a weakness. While correct in his analysis of the role of “debt deflation” – where the deflation increases the real burden of debts and correspondingly weakens the balance sheet of both households and businesses – in the deepening of the Great Depression; his obsession with slaying the Great White Whale of Deflation provided intellectual cover for the Fed’s ignoring and contributing to the housing bubble. Like the proverbial general, he was fighting yesterday’s battle, rather than today’s.

While core inflation was moderate and increasing at a decreasing rate between 2001 and 2005, this measure ignores the dramatic up-tick in house prices during those years. First, housing makes up the single largest expense for most households, ignoring housing, especially after one subtracts out energy and food from the definition of inflation, gives a narrow and distorted picture of inflation. Even if one were to focus solely on rents, the 2000s were an era of increasing housing costs.

Separate from the impact of housing prices on inflation is the role which housing plays as the collateral for the primary piece of household debt: a mortgage. Even were the US to suffer a bout of mild deflation and the real burden of their mortgages increased, this would likely have little impact on household balance sheets in an environment of increasing home prices.

Admittedly Bernanke was then only a “governor” and not yet Chair of the Fed, but he was the Fed’s loudest voice when it came to combating deflation and arguing for lower rates. Additionally there have been zero public acknowledgements by either Bernanke or the Fed that its policy earlier this decade contributed to the housing bubble and financial crisis. Without admitting to the occasional mistake, we have no way of judging whether Bernanke has learned from any of his mistakes, and hence less likely to repeat them.

In weighing Bernanke’s record at the Fed, judgement should not solely consider his actions as Chair, but also consider his words and deeds while the housing bubble was inflating. How one responds to a impending disaster is as important as to how one helps to clean up after the disaster has struck.

Support for Federal Reserve Audit Increasing

Last week Cato hosted a policy forum on “Bringing Transparency to the Federal Reserve,” featuring Congressman Ron Paul. As mentioned in CQ Politics, Rep. Paul’s bill, HR 1207, has been gaining considerable momentum in the House, with currently 244 co-sponsors, ranging from John Boehner to John Conyers Jr. In fact, the Senate companion bill was introduced by Senator Bernie Sanders.

Fed Chairman Ben Bernanke discussed the very topic of Federal Reserve Transparency at Cato’s annual monetary conference in the Fall of 2007.

After praising moves toward greater transparency at the Fed, Bernanke argued that “monetary policy makers are public servants whose decisions affect the life of every citizen; consequently, in a democratic society, they have a responsibility to give the people and their elected representatives a full and compelling rationale for the decisions they make.”

Chairman Bernanke also goes on to argue that “improving the public’s understanding of the central bank’s objectives and policy strategies reduces economic and financial uncertainty and thereby allows businesses and households to make more-informed decisions.” Bernanke’s full remarks can be found in the Spring 2008 issue of the Cato Journal.

Over the last two years, we have seen an almost tripling of the Federal Reserve’s balance sheet to $2.3 trillion, resulting from the bailouts of AIG and Bear Stearns and the creation of 14 new lending programs.

Our recent forum, and Rep. Paul’s bill, bring much needed debate and focus to the issue of Fed’s inner-workings.

Beginning of the End for Bernanke

Fed Chairman Bernanke’s term as Chair ends in January 2010. So far President Obama has offered Bernanke praise for his performance, but little else. After last week’s House Oversight Committee hearing focusing on Bernanke’s role in Bank of America’s purchase of Merrill Lynch, it is now readily apparent that the Chairman has few supporters on Capitol Hill. While his nomination will not be subject to the approval of the House of Representatives, or any of its Committees, the Senate Banking Committee’s reaction to Treasury Secretary Geithner’s plan to extend the Fed’s power serves as a useful proxy in gauging that Committee’s view of the Fed’s recent performance.

Several recent polls show President Obama to be broadly popular with the American public, while the public holds some concern over the scope and cost of his policies. His policy that garners the least support has been his bailout and support for the auto industry. It is no secret that the American public was not enthusiastic about the bailouts at the time, and is even less so now. With Hank Paulson having left the stage, Bernanke is now the public face of corporate bailouts. While having Bernanke around may offer President Obama a convenient target for the public’s anger over bailouts, re-appointing Bernanke would finally force Obama’s hand – so far he’s managed to support the bailouts with little fallout, as Bush and others have taken the blame. Re-appointing Bernanke makes him Obama’s pick.

In addition to political risk to President Obama, one can assume that many Senate Democrats are not looking forward to having to vote for the man who bailed out AIG. It is a fair bet that many Republican Senators would not vote for Bernanke’s re-appointment, leaving it up to the Democrats to secure his re-appointment.

Whatever the merits, or flaws, in his performance as Federal Reserve Chair, support for Bernanke’s re-appointment is becoming a proxy for one’s support, or opposition, to corporate bailouts.

Ron Paul at Cato: ‘Audit the Fed’

When Texas Congressman and former Republican presidential candidate Ron Paul speaks about transparency in the Federal Reserve, he sums up his argument with one simple question. Why not?

“Why in the world should this much power be given to a Federal Reserve that has the authority to create $1 trillion secretly?” Ron Paul asked a standing room-only crowd today at the Cato Institute.

Paul was on a panel of speakers, including Gilbert Schwartz, former associate general counsel to the Federal Reserve, to discuss a new bill that will audit the Fed for the first time in its history. This comes at a time when the Fed’s balance sheet has almost tripled, from just over $800 billion before the financial crisis to almost $2.3 trillion now.

“We will only win when the people wake up and realize that transparency is what we need,” said Paul. “When we know exactly what’s happening, there will be monetary reform.”

Watch the rest of Paul’s comments below:

Now Is Not the Time to Reduce Credit Card Availability

With the House having passed credit card legislation and the Senate scheduled to take up its own bill this week, one questions keeps coming back to me: What’s the hurry?

We are in the midst of a recession, which will not turn around until consumer spending turns around—so why reduce the availability of consumer credit now? And the Federal Reserve has already proposed a rule that would address many of Congress’ supposed concerns. The Fed rule will be implemented July 2010. Were Congress to get a bill to the president by Memorial Day, as he has asked, the Federal Reserve and the industry still couldn’t implement it before maybe January, if they were lucky.

Congress should keep in mind that credit cards have been a significant source of consumer liquidity during this downturn. While few of us want to have to cover our basic living expenses on our credit card, that option is certainly better than going without those basic needs. The wide availability of credit cards has helped to significantly maintain some level of consumer purchasing, even while confidence and other indicators have nosedived.

It was the massive under-pricing of risk, often at the urging of Washington, that brought on our current financial market crisis. To now pressure credit card companies not to raise their fees or more accurately price credit risk, will only reduce the availability of credit while undermining the financial viability of the companies, ultimately prolonging the recession and potentially increasing the cost of bank bailouts to the taxpayer.

As Treasury Secretary Timothy Geithner has repeatedly said, some of the biggest credit card issuers will not be allowed to fail (think Citibank, American Express, Capital One, KepCorp) should they suffer significant losses to their credit card portfolios. Will taxpayers ultimately be the ones covering those losses?

Congress should also further examine the wisdom of restricting credit to college students under the age of 21. Outside of the obvious age discrimination, why treat adults between the ages of 18 and 21 any differently from those above 21? The basic premise of college is making sacrifices today in order to have a wealthier tomorrow—accordingly being able to borrow against that better tomorrow should be an option for any college student. Just as some small number of college students don’t benefit from college, some don’t benefit from credit cards, but throwing the “baby out with the bathwater” hardly seems the idea solution.

Bank ‘Stress Tests’ Need Transparency

As the bank stress tests are released, it is vital that the public receive specific and detailed information on each financial institution.  The Administration’s and the Federal Reserve’s continued policy of attempting to disguise the differing health of each bank has been a failure.  What is best for the taxpayer and the investing public is sufficient information to separate the good banks from the bad.

For those institutions which lack sufficient capital to remain solvent, they should seek private capital or else be closed and resolved.  Too many taxpayer dollars have already been wasted keeping alive failed institutions.  The Administration’s policy of keeping failed institutions on taxpayer-financed life-support only serves to retard the market’s ability to move assets away from those who do not, or cannot, make productive use of them toward those who can.  It is time to remember that the unparalleled wealth-creating engine of the market depends as much on allowing failure as it does in encouraging success.

Banks passing the stress tests should be allowed and encouraged to re-pay their TARP funds as soon as possible, and with no additional strings attached.  More importantly, the Administration should use any returned TARP funds to pay-down the increasing government debt, rather than be diverted to bailing-out other failed companies.