New Monetary Target
By Tom Braithwaite
Financial Times, London
Wednesday, October 7, 2009
It is an unlikely rallying cry. At marches and meetings against big government across the United States, where some placards damn the president, others bear a catchy slogan: "End the Fed."
Even Rep. Ron Paul can hardly believe it. Aged 74, fresh from a quixotic run for the presidency last year, the Texas Republican's pet subject is winning a rash of converts. His book, also called "End the Fed," is riding high in the bestseller lists. In it he writes with delight about students in Ann Arbor, Michigan, chanting the phrase and burning dollar bills in the college quad as they discussed the crimes of the Federal Reserve.
That was before the financial crisis. In the aftermath, the signs and slogans have become more widespread, the anger more vitriolic. "It's understandable," says Mark Zandi, chief economist at Moody's Economy.com and an adviser to John McCain during his presidential election campaign. "Many Americans have been put through the proverbial wringer and they are suffering and they are confused and they are upset."
In Congress too the ideas of a tiny minority obsessed for decades with curtailing the power of the nation's central bank have been supplemented by criticism from the mainstream. "It has become known to many Americans and congressmen that the Fed is more intrusive than we imagined," offers Mr. Paul by way of explanation.
For Mr. Paul and his allies, removing the Fed would end almost a century of rule over the economy by an undemocratic institution that has weakened the dollar and stoked inflation. For most economists, "ending" the Fed -- or just compromising its independence -- could rock financial markets just as the bank weighs up when to tackle the feat of withdrawing the large unconventional stimulus without choking off recovery but before driving up inflation.
The Fed itself has argued that any whisper of political interference with monetary policy will drive up long-term interest rates and cost "current and future generations" of American taxpayers dear in higher costs of servicing the large national debt. Ben Bernanke, who has presided since 2006 over a network of 12 regional Fed banks, approaches a confirmation hearing expected in the next few weeks for a second term as Fed chairman with an unwelcome list of political problems adding to his duties in helping breathe life into an uncertain economic recovery.
A bill from Mr. Paul to audit the Fed has more than two-thirds of the House of Representatives backing it. The Texan's motives are not as nuanced as "audit" suggests -- this is only the "first step" to the eventual abolition of a menace. "They can print money out of thin air and serve special interests," he says. "It's central banking that causes economic bubbles."
It is certainly true that the most recent bubble, its bursting, and the Fed's actions in the aftermath have inspired existing critics and recruited new ones. Their first charge is that interest rates under Alan Greenspan, Mr. Bernanke's predecessor, were kept too low for too long, contributing to a bubble of easy credit.
Second, they say that the Fed's doubling of its balance sheet to more than $2,000 billion, using it to pump liquidity into banks, is an example of an unelected institution -- and one not enshrined in the Constitution -- enjoying too much raw power.
Third, they worry about the ability to lend directly to floundering banks (and since 1991 to non-banks), which had not been exercised since the 1930s but was used during the crisis to prop up Bear Stearns, the investment bank bought by JPMorgan Chase, and AIG, the insurer now majority owned by the government. Concern centres on the diversion of billions of dollars of public money into private enterprises, with no certainty of repayment.
Fourth, plenty of politicians and other regulators say, the Fed should lose its responsibilities for protecting consumers (because it failed in doing so) and should not gain new powers for supervising systemic risk (because other regulators should have a hand in that too).
Then there is criticism that predates the crisis. Some Fed supporters believe that is sometimes motivated by a long-standing anti-Semitic conspiracy theory that places the Fed at the heart of a cabal of Jewish bankers working for their own ends and foreign interests at the expense of the country.
But there does not have to be a racist taint to the charge that the Fed is anti-transparent, secretive, and deliberately gnomic in its statements. Robert Auerbach, former chief economist for the House banking committee, recalls being sent to the New York Fed in the 1980s as a congressional investigator to go 80 feet below ground into a vault that holds what is believed to be the largest collection of the world's gold. The reason? To "check it was there." That was the level of mystery and mistrust between Congress and the Fed.
Rep. Barney Frank, the Democrat now chairing the same powerful committee, remembers the change in policy in 1995 that brought in statements after monetary policy meetings revealing any change in the target federal funds rate. "How you set interest rates without telling people, God only knows," he says.
Alan Blinder, former Fed vice-chairman and now Princeton economics professor, asks: "Over decades was the Fed vastly too secretive for very poor reasons? The answer is absolutely yes. If you go back to the way the Fed behaved imperiously one might say in the '50s, the '60s, the '70s, the '80s. There is a reason to gripe about that."
But things have changed. Even some critics of the Fed acknowledge that it has become more transparent. Mr. Auerbach and Mr. Paul say that Mr Bernanke's attitude is an improvement on Mr Greenspan's. Under pressure it has started publishing a monthly balance sheet, containing a wealth of information but not the names of those banks that have tapped its credit facilities. That has developed into a minor cause celebre for Bloomberg news agency, which is pursuing the bank through the courts under the Freedom of Information Act.
Although the Fed has become more transparent, so long is the history of secrecy that perception lags behind reality. Mr. Bernanke has inherited a "boy who cried wolf" position. So often has the Fed warned of disaster if its authority is tampered with that the current chairman has a hard task to persuade politicians when he identifies furry menaces on the horizon.
As each step into the sunlight fails to bring calamity -- no one blames the latest crisis on too much central banking transparency -- the Fed is left with a thinner margin of confidentiality and a weaker hand if it really needs to resist future calls for more openness.
Most economists argue there is something worth preserving. "I think Congress has to be very careful in changing its relationship with the Federal Reserve so as not to affect the independence of the Fed, actual or even just perceived," says Moody's Mr. Zandi. "Global investors are particularly sensitive to the prospect that the Federal Reserve will be under pressure to monetise all the debt that is being created," he says. "I think it's fair to say that the most significant strength of our financial system is the independence of the Fed."
For now, there is no evidence that foreign investors are unwilling to swallow US debt: long-term bond yields remain low. The Fed has warned that if Congress takes a more active interest in monetary policy, investors will fear rates will be kept too low in the short term as rate-setters fret about political pressure -- and that long-term rates will rise as inflation fears increase as a result, adding to the cost of debt for "generations" of Americans.
As Congress weighs reform options for the financial system, the worst-case scenario for the Fed is still on the table: it loses its consumer protection authority; it loses its bank supervision powers; it is not given primary responsibility for systemic risk regulation; it endures sweeping audits, including scrutiny of its swap lines with foreign governments; it has to publish the names of counterparties.
Mr. Bernanke and Scott Alvarez, the Fed's general counsel, have helped themselves in recent testimony to Congress. Refusing to be riled by hostile questions before Mr Frank's committee, the pair have sought to assuage lawmakers' fears without resorting to the lecturing characteristic of some former Fed officials.
They have submitted themselves to browbeating by Mr. Frank, who railed against the previous lack of transparency and published a list of alleged failings in consumer protection. "The Fed is a lousy consumer regulator," he says. That belies the fact that Mr. Frank, like Tim Geithner, the Treasury secretary and former president of the New York Fed, is seen as sympathetic to the central bank.
Indeed, this hairshirt treatment could offer a route to a liveable middle ground -- between ending or severely restricting the Fed's powers on the one hand and preserving and reinforcing them on the other. But it will require all the political savvy of Mr. Bernanke and his staff in what is an avowedly apolitical organisation.
Under this course, consumer powers would go to a new agency, an outcome that is feared by banks but continues to enjoy the support of President Barack Obama -- while many in Congress either support it or are afraid of voting down any legislation that is seen as pro-consumer.
This is not a disaster for the Fed. When Mr Obama interrupted his vacation on Martha's Vineyard in August to stand shoulder to shoulder with Mr. Bernanke and announce he was reappointing the Fed chairman, he gave the clearest signal of his administration's support for the institution.
The administration, and particularly the Treasury under Mr. Geithner, is working closely with Mr. Frank to keep the Fed from being scarred too badly. It was the Treasury that came up with the plan for regulatory overhaul in June in which the Fed took the lead role in systemic risk regulation and was forced to cede only its consumer protection powers. More importantly, any new audit powers for Congress' Government Accountability Office would stop short of scrutinising monetary policy or publishing interactions with other countries.
But some Fed watchers are still worried about Mr Bernanke's ability to pull that outcome out of the congressional flux. "I think not easily at all," says Mr. Blinder. "At this point, it's swimming upstream."
Still in the bookshops, on the marches, on signs, and on T-shirts and all over the Internet is, meanwhile, that catchy slogan. The Fed needs a knockout response.
Proposed changes range from the plausible to the "very pernicious."
The Federal Reserve's battle in the regulatory overhaul now under way in Congress would not be so arduous if the central bank were not having to fight on so many fronts.
Ron Paul's popular bill to audit the Fed more thoroughly is the only one that presents, the bank believes, a threat to monetary policy. But in the words of Alan Blinder, the former Fed vice-chairman, it is "very pernicious though very unlikely to pass." The Senate may provide the resistance that Mr. Blinder expects.
Next in seriousness would be moves to strip the Fed of its powers of bank supervision, using the argument that it did not do enough to prevent the banks under its watch from taking on too much leverage and risk.
Here, the Senate under the Banking Committee of Chris Dodd is the proponent of change. He wants a far more radical consolidation of the four bank regulators than proposed by the administration of President Barack Obama, which has suggested only one merger -- between the Office of Thrift Supervision and Office of the Comptroller of the Currency.
The one new power the Fed would gain under the reforms proposed by the administration is as the lead regulator in the supervision of systemic risk -- problems such as AIG's credit default swap positions last year -- which can quickly spiral out from one institution to threaten the whole financial network.
This is proving to be one of the most bitterly fought turf wars, although Ben Bernanke, chairman of the Fed, is fighting with more calm than other regulators. He is relying on the persuasive power of Tim Geithner, Treasury secretary, who is adamant that the Fed must have this responsibility, not a new "council" of regulators.
But the Federal Deposit Insurance Corp. under Sheila Bair, its politically powerful chairman, is among the regulators arguing that the new council is perfectly capable in the practice as well as the theory of regulating systemic risk.Finally, the Fed is likely to lose its powers of consumer protection to a new Consumer Financial Protection Agency. That is in spite of Mr Bernanke's testimony that there are disadvantages in separating the supervision of consumers' safety from the safeguarding of the "safety and soundness" of the banks. But if this is the only front on which he loses, Mr. Bernanke will have had a good regulatory war.