Time for the Fed to stand up to its critics

August 20, 2009

John M. Berry is a guest columnist who has covered the economy for four decades for the Washington Post and other publications.

By John M. Berry

Financial crises and the policies to deal with them top the agenda at the Kansas City Fed’s Jackson Hole conference. But what is actually going to be on everyone’s mind at the august gathering is the uncertain future of the Federal Reserve itself.

Many members of Congress want to clip the Fed’s wings for failing to prevent the crisis and for its actions since the meltdown began two years ago. In particular, most are angry about government bailouts, starting with the $29 billion in Fed backing for the purchase of Bear Stearns by JPMorgan Chase.

Financial institutions got into trouble because they took enormous risks, and the public bailouts look suspiciously like unjustified rewards for fat cats’ wildly reckless behavior. But the bailouts were an unavoidable cost of halting the country’s plunge into a second Great Depression. Congress has got to swallow its anger and do what is needed for the future.

The first objective on the financial reform agenda when Congress reconvenes next month should be to do no harm. That means killing legislation that would direct the Government Accountability Office to “audit” the Fed’s monetary policy actions. Such audits could allow politicians to influence those decisions, which is exactly what some of the bill’s sponsors want.

Angry as they may be at the central bank right now, members of Congress would surely rue the day they had to deal directly with raising interest rates — a step that will inevitably be needed at some point to curb inflation and keep the economy on an even keel.

Whatever else the role of the Fed is to be, its monetary policy independence should be preserved as it pursues its twin mandates of stable prices and maximum sustainable employment. And Fed officials need to be insulated from political pressures.

In return for that insulation, the Fed has become ever more open and accountable. Since 1994, the central bank has started announcing policy changes as soon as they are made, quickly publishing detailed minutes of policymaking meetings, and releasing transcripts after a five-year lag. It also now makes public details of the long-term forecasts of its top officials.

The second Fed role that must be preserved in the national interest is that of lender of last resort to financial institutions. Solvent banks that get squeezed for cash must be able to borrow directly from the central bank to prevent a failure that could trigger a collapse of other institutions.

Of course, the Fed, led by Ben Bernanke, went far beyond that traditional lending role last year. Citing legal authority not used since the 1930s, it loaned money not just to banks but to brokers, investment banks and insurance companies. And when that failed to stabilize money markets, it risked hundreds of billions of dollars of taxpayer money to buy mortgage-backed securities and other private credit instruments to make credit more available to businesses and households.

Bernanke and other Fed officials were uncomfortable extending credit in these unusual ways, which really ought to have been the Treasury’s responsibility. But, objectionable as they were to many members of Congress and to a number of economists, these measures have proved essential. In any case, the Treasury Department did not have the money or the authority to act. To settle this for the future, Treasury should be granted both under the financial system overhaul.

There is also plenty of opposition to the administration’s proposal to give the Fed broad oversight of financial markets as a regulator of systemic risk. The crisis has demonstrated that such a regulator is badly needed, and the Fed should win this one by default. Despite the central bank’s failure to head off the crisis, there is simply no other agency — not the Securities and Exchange Commission, the Federal Deposit Insurance Corp, the Comptroller of the Currency or any other — capable of doing the job.

As for the remaining key issue, consumer protection, Bernanke should cede responsibility for truth-in-lending and all related activities to the new consumer agency proposed by the administration. If he does that, the Fed will be more likely to keep the powers it really needs.


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