Tag: Federal Reserve

The Federal Reserve’s “Foreign Banking Organization” Rule Is Unnecessary

Last November, Arthur Long and I released a policy study on the likely impact of the Federal Reserve’s 2012 “Foreign Banking Organization” proposal.

We argued – along with many others – that the proposal amounted to little more than a costly corporate reshuffling exercise. Of even greater concern, we suggested that the proposal threatened the ability of global banks to allocate capital and liquidity in an efficient manner, would increase financial instability, and dampen economic growth.

Yesterday, the Federal Reserve released a final rule that is essentially the same as the original proposal. The final rule is more lenient only in the sense that it increases the timeframe for compliance, simplifies the leverage requirements a little, and impacts fewer organizations. To that end, the fundamental criticisms still apply, as does the confusion around why such a proposal is necessary.

Governor Tarullo – a leading proponent of the rule – has argued that the Federal Reserve extended financial “support” to foreign banks at unprecedented levels during the crisis and therefore should be given greater oversight of these banks’ activities. That sounds reasonable. But upon closer review, the support he refers to was limited to liquidity provided through the Fed’s discount window. Foreign banks were not eligible to receive TARP or other forms of bailout assistance.

Fed officials have gone to great lengths to argue that providing liquidity through the discount window (which may be provided only to otherwise solvent institutions on a fully collateralized basis) is a legitimate central bank function and is NOT financial assistance constituting a bailout.

I agree (although on this point, I note that I depart quite radically from some of my contemporaries). However, this argument does undermine the central pillar supporting the Fed’s new rule. In addition, if protecting U.S. taxpayers is the fundamental aim, why implement a rule that will close-off the channels of liquidity and support that the U.S. subsidiary could receive from the foreign parent? 

The Fed’s rule may well spark retaliatory actions from foreign regulators, who are even more annoyed about it than the banks they oversee. The losers will be both local and foreign banks and, most importantly, consumers of credit. Governor Tarullo himself noted during yesterday’s open meeting that the rule “may not strike the right balance indefinitely.” The Fed had an opportunity to lead from the front. That it failed to do so is unfortunate. 

Yellen and the Fed

The Senate Banking Committee just voted 14 to 8 to confirm Janet Yellen’s nomination to be the new Chair of the Federal Reserve. She will likely go on to be confirmed by the full Senate.

Much of the coverage has focused on Yellen as a person, when the real story is on the Fed as an institution. Sometimes individuals have profound influence on Fed policy, such as Paul Volcker  in the late 1970s and 1980s. Over time, however, the institutional structure of the central bank and the incentives facing policymakers matter more.

The Federal Reserve famously has a dual mandate of promoting maximum employment and price stability. The Federal Open Market Committee, which sets monetary policy, has great discretion in weighting the two policy goals. As a practical matter, the vast majority of the time, full employment receives the greater weight. That is because the Fed is subject to similar pressures as are the members of Congress to which the Fed must report. In the short run, voters want to see more job creation. That is especially true today. The United States is experiencing weak growth with anemic job creation.

Never mind that the Fed is not capable of stimulating job creation, at least not in a sustained way over time. It has a jobs mandate and has created expectations that it can stimulate job growth with monetary policy. The Fed became an inflation-fighter under Volcker only when high inflation produced strong political currents to fight inflation even at the cost of recession and job creation.

The Federal Reserve claims political independence, but it has been so only comparatively rarely. Even Volcker could make tough decisions only because he was supported by President Carter, who appointed him, and President Reagan, who reappointed him. Conventionally defined inflation is low now, so the Fed under any likely Chair would continue its program of monetary stimulus. Perhaps Yellen is personally inclined to continue it longer than might some other candidates. But all possible Fed chiefs’ would face the same pressures to “do something” to enhance job growth, even if its policy tools are not effective.

The prolonged period of low interest rates has made the Fed the enabler of the federal government’s fiscal deficits. Low interest rates have kept down the government’s borrowing costs, at least compared to what they would have been under “normal” interest rates of 3-4 percent.

Congress and the president have been spared a fiscal crisis, and thus repeatedly punted on fiscal reform. They are likely to continue doing so until rising interest rates precipitate a crisis. How long that can be postponed remains an open question.

Does Janet Yellen Know What a Bubble Looks Like?

With Larry Summers withdrawing from the race for Federal Reserve chair, current Fed vice chair Janet Yellen has pulled into the lead to become Ben Bernanke’s replacement. Previous to her current appointment, Yellen served as president of the San Francisco Federal Reserve Bank  The SF Fed’s district includes three of the worst states in the housing crisis – California, Arizona and Nevada.  I think its fair to say that without the housing boom and bust in these states we wouldn’t have had a mortgage crisis.  Given that Yellen was the top banking regulator for this geography, one has to wonder whether she was asleep at the wheel.  

This issue wasn’t ignored at her confirmation hearing for Fed vice chair.  Here’s a little of her exchange with Sen. Richard Shelby (R-Ala.):

SHELBY: And regarding your tenure as president of the 12th District, I have two questions. First, what role do you believe a breakdown in regulatory oversight played in the failure of the institutions in your district? And secondly, were you raising any warning flags with respect to speculative excesses or lax monetary policy during that period?

YELLEN: So the first question was to the breakdown – to the breakdown in…

SHELBY: Do you believe a breakdown in regulatory oversight – what role do you believe that a breakdown in regulatory oversight played in the failure of the institutions in your district?

YELLEN: Working with other regulators, I think that our regulatory oversight was careful and appropriate, but I believe that the…

SHELBY: Well, excuse me. You say it’s careful and appropriate, and you – most people believe…

YELLEN: Given the…

SHELBY: … it was lax and inappropriate.

YELLEN: Well, I – in the institutions that have failed in my district are mainly community banks with high exposure to commercial real estate.

SHELBY: OK.

YELLEN: And when I say careful and appropriate, I mean that as early as 2001…

SHELBY: OK.

YELLEN: … people in the Federal Reserve System, and particularly in my bank, were at the forefront of focusing on high concentrations that existed in the banks we supervised in commercial real estate. We saw that these exposures and concentrations could be a source of vulnerability, and we monitored this carefully throughout.

Interestingly enough she never touches on the topic of monetary policy and its impact on housing prices.  When the Fed hasn’t been complicit in generating bubbles, they’ve generally just turned a blind eye to them.  If one cannot from the perch of San Francisco identify the perverse impact of loose money on housing prices, then you’re likely to miss it from D.C. as well.

If you think bubbles are a great avenue for wealth creation, then Yellen is the Fed chair for you.  If you, however, suspect bubbles are damaging to our economy, then you might rightly be concerned that she repeats her San Francisco performance on a national level.

Yay Authoritarianism!

Cato-at-Liberty readers who are enjoying—or, at least, chronicling—our nation’s slide down The Road to Serfdom will have to add Neil Irwin’s Washington Post Outlook piece, “Why the financial crisis was bad for democracy,” to their travelogue:

In a democratic society, there will always be tension over which decisions should be made by expert appointees, and which by those with the legitimacy and accountability that come with competing for citizens’ votes. The technocrats can make complex decisions quickly, quietly and efficiently. The words “quick, “quiet” and “efficient” are rarely applied to the U.S. Senate or the Italian Parliament — but these institutions are imbued with an authority that comes directly from the people, the explicit consent of the governed.

So, in a crisis, which do you want: unaccountable decisiveness or inefficient accountability?

Consciously or not, we’ve made our choice: The financial crisis and its long, ugly aftermath have marked the triumph of the technocrats…

None of this is a great way to run a society. Like most journalists, I believe in transparency and accountability. I wish the Federal Reserve’s policy meetings were broadcast on C-SPAN. Instead, we get written transcripts five years later. (That still beats Europe, where such information is under lock and key for 30 years.)

Yet, when the world is on the brink, decisive problem-solving trumps the niceties of democratic process. I won’t like it much — but I’ll take it.

Authoritarianism cannot take hold without intellectual support, and Friedrich Hayek couldn’t have described the rationale better himself. Just equally well. Almost verbatim, actually.

For more, see my paper (with Diane Cohen) on IPAB and this Cato policy forum on IPAB and Dodd-Frank. And of course, read Hayek’s The Road to Serfdom while it’s still legal.

The Fed: ObamaCare “Leading to Layoffs”

The Hill has the story:

The Federal Reserve on Wednesday released an edition of its so-called “beige book,” that said the 2010 healthcare law is being cited as a reason for layoffs and a slowdown in hiring.

“Employers in several Districts cited the unknown effects of the Affordable Care Act as reasons for planned layoffs and reluctance to hire more staff,” said the March 6 beige book, which examines economic conditions across various Federal Reserve districts across the country.

Or in other words, yes, ObamaCare will eliminate some 800,000 jobs.

The Fed’s New Round of Quantitative Easing

Last Thursday, the Fed announced its intention to proceed with another round of quantitative easing, or QE3. To summarize my reactions:

  1. By introducing another program to buy MBSs, to the tune of $40 billion per month, the FOMC is supporting the long-standing federal policy of special aid to housing, real estate and mortgage interests. These federal policies were the largest single contributor to the financial crisis. Why would the Federal Reserve want  to encourage continuation of these federal policies? Almost every economist, except those allied with housing interests, agrees that the mortgage-interest and real-estate tax deductions in the federal tax code should be eliminated or scaled back. I’ll wager that almost every Federal Reserve economist shares this view. The Federal Reserve says that it is apolitical but this decision is directly supportive of continuation of the current status of Fannie Mae and Freddie Mac. This action is not monetary policy but fiscal policy, extending credit to a favored industry. This policy is crony capitalism, whether practiced by the federal government or by the Federal Reserve.
  2. The FOMC’s decisions create yet another exit problem for the Fed. If job growth picks up, or inflation rises, before every future FOMC meeting the market will wonder if the Fed will stop buying MBSs. The Fed has refused to offer any genuine guidance as to when the policy will end. Conversely, if job growth remains weak, market participants will wonder before every FOMC meeting whether the Fed will do more, or introduce some new and untried policy.
  3. In his press conference, Chairman Bernanke appropriately emphasizes the need for fiscal policies to stabilize federal finances. Yet, he is promising that the Fed can make a material contribution to bringing down unemployment. That promise reduces the pressure on Congress to act. Why should Congress deal with the tough political issues if the Fed can do the job, even if more slowly than if Congress acted?

Dimon on NY Fed Board a Distraction, Solution Is to Remove the Fed from Bank Regulation

It is not surprising that the recent losses at JP Morgan have resulted in calls by current and would-be politicians to remove bankers from the boards of the regional Federal Reserve banks, as JP Morgan CEO Jamie Dimon currently sits on the board of the New York Federal Reserve. There’s even a petition for the “public” to demand Dimon’s resignation. Setting aside the irony of having senators call for keeping bankers off the regional Fed boards just days after they voted to place a former investment banker on the Federal Reserve board, the real question we should be debating is: Should the the Federal Reserve even be involved in banking regulation?

As I’ve noted elsewhere, a recent paper by economists Barry Eichengreen and Nergiz Dincer suggests that separating monetary policy from banking supervision would yield superior outcomes, both for banking stability and the economy more generally. While there is a very real conflict-of-interest when bankers sit on the boards of their regulators, there is an even bigger conflict-of-interest when those setting monetary policy are also responsible for bank safety. Rather than let institutions they supervise fail, and face public criticism, there exists a strong incentive for the monetary authority to mask bank insolvency by labeling such a liquidity crisis and then injecting easy and cheap credit. The result is that the rest of us are left paying for the mistakes of both the bank and regulator. A far better alignment of incentives would be to separate the conduct of monetary policy from bank supervision.

Like anything, such a separation would not be without its costs. I am the last to go around claiming a “free lunch” when it comes to banking and monetary policy. The current Boston Fed President made a strong case over a decade ago for keeping the two combined. The Richmond Fed has also offered a useful discussion of the pros and cons of such consolidation, as well as consolidating regulators more generally. These costs aside, I believe having the Fed focus solely on monetary policy would improve both.

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