Fed Up with the Fed

Politicians want political control. Regulatory economists want the ability to operate without catering to the political pressure du jure. And most folks don’t have a clue about what’s right or what should happen, because it is just too complex for the layperson to understand. And like most regulatory bodies, the roots of the Federal Reserve Bank, our major monetary policy instrument, were fertilized in pain.

Over a century ago, the “Panic of 1907” sent Wall Street stocks plunging (by half), folks ran to pull their money out of banks and trust companies, and a ravaging recession pushed economic chaos and bankruptcy across the nation. Sound familiar? The brakes on this free fall came not from the federal government (there was no central bank to push money into this dehydrated financial system), but from the efforts of mega-banker J.P. Morgan (pictured above) who pledged his own funds and convinced a number of other bankers to furnish the necessary liquidity to the American banking system out of their own pockets. The U.S. economy was still relatively small, especially when compared to its European counterparts, and the nation was still struggling with the complexities of modern economics.

The Panic pointed out a governmental capacity that was sorely lacking at the time: a central bank that could push money into the system when needed or contract money out (by making it more expensive) to create more stability in the currency and financial markets. Congressional leaders looked to the central banks in Europe for their inspiration, but many Americans were suspicious that such a centralized institution would effectively be run for the benefit of the mega-bankers like J.P. Morgan and not for the betterment of the general public.

The 1913 bill creating the Federal Reserve came from commissions headed by a noted Republican and had initial Republican support as a private bank, but when the bill finally came to a vote, Republicans mostly voted against the legislation, liberal Democrats wanted it to be a directly controlled branch of the federal government, and conservative Democrats wanted this bank to be a separate government corporation, out of the range of powerful bankers like Morgan (made worse by his daughter’s marriage to a Rockefeller).

The ultimate result: The Fed (including its 12 branches) is a quasi-governmental corporation, but it is not a part of the federal government and it is not owned by anyone. The President appoints the board of directors, including of course the chairman, subject to Senate confirmation. They serve long, 14-year, staggered terms, to insulate them from political vagaries (the chairman gets a 4-year term). The Federal Reserve (according to Wikipedia) has the following responsibilities (which have changed over time in reaction to financial crises):

1. Conducting the nation's monetary policy by influencing monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates.
2. Supervising and regulating banking institutions to ensure the safety and soundness of the nation's banking and financial system, and protect the credit rights of consumers.
3. Maintaining stability of the financial system and containing systemic risk that may arise in financial markets.
4. Providing financial services to depository institutions, the U.S. government, and foreign official institutions, including playing a major role in operating the nation's payments system.

Why does any of this remotely matter? Because in the interest of stability, the Fed is charged, as one of its primary duties, with preventing “bubbles” (like the real estate bubble and all the underlying lending that exploded into the current financial mess) and, when “bubbles” occur, to mitigate the damage they cause. And while Fed. Chairman Ben Bernanke is likely to be confirmed for another term in his current role, and even though he is credited with having reacted well to the financial damaged caused by the recent bubble, the harsh reality is that the Fed, much like Wall Street, fell victim to the unsustainable myth – “conventional wisdom” – that accelerating real estate prices and the easy access to mortgage money were not systemic problems for the U.S. economy. They were wrong – dead wrong!

The January 6^th New York Times illustrates: “In 2004, Alan Greenspan, then the chairman, said the rise in home values was ‘not enough in our judgment to raise major concerns.’ In 2005, Mr. Bernanke — then a Bush administration official — said a housing bubble was ‘a pretty unlikely possibility.’ As late as May 2007, he said that Fed officials ‘do not expect significant spillovers from the subprime market to the rest of the economy.’” The Fed wants an expanded role in the regulation of financial institutions to prevent bubbles – but they didn’t see this huge one coming – and a number of Congress men and women, want to impose more direct, control over the entire Federal Reserve System, incl uding the right to review and alter Fed-set interest rates.

What really pisses folks off is that Bernanke is making lots of speeches about what should be done in the future and how well the Fed reacted to the current crisis, but notably absent from these talks is any explanation of why the Fed missed this bubble and why they are the right folks to prevent the next possible bubble. My opinion? The Fed cannot become subject to the whims of political trends and be subjected to the pressures that all politicians succumb to, but likewise, it owes the American people a damned good explanation of why it erred so badly in predicting this obvious path to destruction, how they will resist the pressure of defying conventional (destructive) wisdom, what steps they are taking to better predict and deal with future bubbles and what fundamental changes in their analysis will take place to make sure Americans are protected against such economic destruction. The Fed owes us a new mission statement!

In fairness, the Fed hasn’t been a complete bust for taxpayers; in 2009, the Fed made a big profit – $45 billion to be precise – generating interest income from everything from emergency bank loans to its investments in U.S. government debt and mortgage-related securities. All that money is going back to the Department of the Treasury at a time when the country needs cash badly. That still doesn’t excuse its bigger missteps or tell the American public how the Fed plans to avoid its herd-like following of misguided “conventional wisdom” and substitute a future of astute leadership and objective analysis instead.

I’m Peter Dekom, and this is one of America’s biggest issues.