Tag: Federal Reserve

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.

The ‘Dodd Rule’ on Nominations

Obama’s recent nomination of Jeremy Stein and Jerome Powell to the Board of Governors of the Federal Reserve System raises an important question: How should the Senate treat nominations whose terms are likely to run beyond the term of the current president? If confirmed, Stein could serve until 2018 and Powell until 2014. Of course this pales in comparison to current governor Janet Yellen, whose term runs until 2024.  With or without Stein and Powell, Obama nominations will have control of the Federal Reserve for years to come.

The long terms of Federal Reserve governors are meant to insulate them from political pressure. But that’s after they’ve been confirmed.  This structure tells us little about how to handle such appointments during their nomination phase.

In the absence of strong policy or theoretical rationales, we often look to precedent. In this case we have at least one. In December of 2007, almost a year before the November 2008 election, then Senate Banking Committee chair Chris Dodd (D-CT) said, in relation to the nomination of Randall Kroszner to the Federal Reserve, “We’re frankly getting down to less than a year away from the election. On nominations of that length, I’m fairly reluctant.” Senator Dodd acted (or rather failed to act) on that reluctance, and blocked the nomination of Professor Kroszner.  His nomination was not an exception, as the nominations of Larry Klane to the Federal Reserve and a couple of nominations to the Securities Investor Protection Corporation were also blocked, for apparently this same reason. Dodd also delayed nominations to the President’s Council of Economic Advisers, although those positions would have ended with the term of President Bush. Also worth noting is that these important economic policy positions were being blocked in the middle of a recession and financial crisis, when one would think you need “all hands on deck.”

Is this “Dodd rule” the correct position? It’s hard to know. I can say I didn’t think it was appropriate at the time. And I am usually not one to believe that “two wrongs make a right.” The correct solution, in my view, would be to have the Senate decide upon the appropriate length of time before a presidential election that it will no longer consider nominations that run beyond the president’s term and incorporate that decision into the Senate rules.  Until then operating under the “Dodd Rule” strikes me as fair enough.

Bernanke’s Anti-Stimulus

One of the direct results of the Federal Reserve’s zero interest rate policies has been a massive reduction in interest income going to households. Since 2008, household interest income has fallen by about $400 billion annually. That’s $400 billion each year that families have not had to spend.

Now of course you can also argue that families interest expenses have also fallen, and that would be true, but that just serves to illustrate that much of monetary policy is not about creating wealth, but re-distributing it. Since interest payments are one’s person expense and another’s income, Fed driven changes in the interest rate should not increase household income in the aggregate.

As interest income/expense is not the only item on the household balance sheet, the Fed does try to make us feel richer via changes in asset prices. The problem, however, is that the change in many asset prices can also have little more than distributional effects. If owners feel richer because their house prices have gone up, or not fallen as much as they would have otherwise, then renters are poorer as they need to save more to by the same house. The same holds for commodity prices. Monetary driven increases in the price of food might be great for farmers, or speculators, but it makes households poorer by the same amount it increases the wealth of commodity holders. If the Fed truly wished to help our economy get back to “normal” then it would allow the free choices of individual borrowers and savers to determine the interest rate. It would also end its implicit practice of picking winners and losers in our economy. Unlike Fed driven changes in asset prices and interest payments, voluntary exchange between savers and borrowers increases the welfare of all parties involved.