Wanted: A Sound Money Congress to Discipline an Inflationary Fed

Janet Yellen makes her first appearance before Congress as the chair of the Federal ReserveThe February 11 testimony of Janet Yellen, the new Chairman of the Federal Reserve Board, to the House Financial Services Committee, described the Fed as “transparent and accountable.” However dubious a description this may be, four transparent intentions of the Fed did come through:

1. The Fed continues its absolute commitment to perpetual inflation. The goal of inflation forever, at 2% or so, was treated as settled and obvious, not requiring any additional thought or argumentation. This is in spite of the fact that in the Federal Reserve Act, Congress explicitly charges the Fed with maintaining “stable prices”– a term the Fed chooses to reinterpret to mean “ever rising prices.”

2. The Fed is determined not to accept responsibility for any deleterious effects of the global asset inflations it has created. The testimony briefly mentioned the “volatility” in emerging markets of late, dismissed it (arguably incorrectly) as posing no risk to the U.S., and made no reference to its relationship to the Fed’s own money printing operations. Of the dollar collapse of the 1970s, then-Treasury Secretary John Connolly famously asserted, “It’s our currency, but your problem.” The Fed’s current variation is apparently, “It’s our QE, but your problem.”

3. The Fed’s regular reports to the Congress are a result of the 1977-78 attempts of the Congress to get more control of the Fed—an unsuccessful attempt. The Fed is clearly determined to keep it unsuccessful in substance, while fulfilling the required formalities. The testimony assumes the Fed can and will decide what to do by itself. Historically, the idea was that a sound money Fed needed to be independent of naturally inflationary politicians. But should a sound money Congress ever discipline an inflationary Fed? The Fed certainly does not want fundamental questions about its governance reconsidered, which they certainly need to be.

4. The Fed is committed to ever more elaborate and burdensome financial regulation. “The work of making the financial system more robust has not yet been completed,” the testimony says. Since the Fed has already been working on this for 100 years while booms and busts continue, it doesn’t seem likely that regulatory expansion will ever be completed, alas. Meanwhile, there was no mention in the testimony of the greatly expanded interest rate risk which the Fed’s own bond market manipulations have doubtless introduced into the entire financial system.

As always with the Fed, the Roman poet Juvenal said it all: “Sed quis custodiet ipsos custodes?”—But who will guard these guardians? Who indeed?

Alex J. Pollock

Alex J. Pollock is a Resident Fellow at the American Enterprise Institute in Washington, DC. He was President and CEO of the Federal Home Loan Bank of Chicago from 1991 to 2004.

About the Author

Comments

  1. nobody.really says

    Oh please.

    1. 12 USC § 225a directs the Board and the Federal Open Market Committee “to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”

    In short, there IS no duty to pursue stable prices at the expense of all other goals; quite the opposite. Your obsession >< the Fed’s duties.

    2. More to the point, what evidence is there that pursuing a policy designed to achieve 2% inflation results in higher inflation than past Fed policies? In short, are you bitching about outcomes, or just about the candor with which the Fed pursues its outcomes?

    3. If the Fed is concerned about promoting the economies of other nations, I can scarcely think of a better policy than to stimulate the US economy and get Americans buying and selling again. The consequences of a growing US economy and consumer base swamp the effects of Fed’s monetary policy overseas.

    And if anything, I’d think that the Fed’s policy of keeping interest rates low is having the effect of freeing up capital to be invested elsewhere, including the developing world.

    4. Why would anyone think that Congress has a greater fiscal discipline than the Fed?

    5. Yup, 100 years of financial regulations has not stopped the business cycle. But the business cycle existed prior to 100 years ago. And between the Great Depression and the Reagan years, the business cycle was greatly reduced. Deregulation has arguably unleashed the business cycle again (perhaps along with a faster rate of growth).

    In short, the evidence favoring financial regulation seems pretty good to me. It’s deregulation that seems iffier.

  2. gabe says

    Really! I suppose that the asset bubble in real estate was due to “DE-regulation.”
    On the contrary, it was due to regulations imposed by statists wishing to assure equality (whatever that means) in home ownership such that Banks were compelled to loan to folks who could not afford it and whom, prior to this intervention, the banks would never consider lending to.

    One could point to any one of hundreds of other supposedly “de-regul;ated markets and find the stealthy influence of YOUR government.
    No thanks, I will pass again.

    • nobody.really says

      There is a myth that government-mandated policies to push down lending standards triggered the mortgage crises, but this story is not supported by either the January 2011 Financial Crisis Inquiry Commission’s report, or the work of investigative journalists, including the Peabody Award winning analysis by National Public Radio entitled “The Giant Pool of Money.”

      In short, yes, there are some policies promoting encouraging banks to offer mortgages to people who lack certain traditional indicia of wealth. But it was not the regulated banks that went broke due to these loans. Rather, it was non-bank lenders such as Countrywide and Washington Mutual – organizations that had no such mandates — and then the investment banks that underwrote these organizations.

      When Fannie Mae and Freddie Mac originated almost all mortgages, default rates were tiny. It was the growth of non-bank loan originators that prompted to rise of subprime mortgages. Fannie Mae and Freddie Mac were legally precluded from getting into the subprime business until just before the crash, and were only authorized to get into the business because their share of the mortgage market has dwindled in the face of the under-regulated competition from the non-bank lenders.

      In conclusion: Under-regulation done it. Or, to phrase it differently, we made a social choice to have greater growth but with greater risk – and that choice ultimately bit us in the ass.

  3. gabe says

    Nobody believes these “Fractured Fairy Tales” (a popular cartoon show of the 1960’s) that all that is required for a sound economy is another dose of regulation or that such regulations do not generate “perverse incentives.”

    Fannie and Freddie served the role of “market makers” via their setting of acceptable (read: required) standards for loan origination and associated requirements. This TOLD the market what they should do – (loan to previously non-preferred applicants) – and was backed by the force of the US Congress. There are interesting tapes of the Honorable (?) Barney Frank opining that he “was prepared to roll the dice a little more” when it came to continuing the loose lending standards imposed upon the industry by the Federales.
    couple this with the substantial fines imposed by the Federales on Bank of America, Wells fargo and the threats of fines on other banks and it is clear that this was NOT an unregulated market.

    What then was the incentives engendered by these policies? Quite simply: Lend your BUTT off or face the consequences and make sure minorities and poor people get their share or we will fine you.
    What does one do when so confronted. why, of course, let’s lend like crazy and hope that we don’t loose too much.
    Once it was clear that they would lose, the answer was to collaterize the debt. Oh, and guess who was at the head of the line to buy these CDO’s – Fannie and freddie as well as duped investors.
    If you were a mortgage broker or sales rep – why would you not book loans at the highest possible rate especially when lending standards at the instruction of your government were virtually non-existent? or so diluted that it was essentially pointless to exercise any scrutiny. If you did, you will lose out on bonuses AND someone, somewhere was going to loan money to these folks – after all, that is what your government wanted – so why not book the loan and make some money.
    (No, I am not excusing these folks – simply pointing out how government regulation and directives corrupt and influence incentives).

    The Fed has not done a very good job of managing the “business cycle” precisely because it is a pretense that they know how! furthermore, they are not quite as independent as some allege and have been known to be susceptible to political influence (witness the Fed action during the campaign of 1992 and the effect it had on GW Bush’s election prospects). Keep ‘em out of it – all they do is debase the currency and their policy of low interest rates ENABLES the Federales to continue running up huge deficits by make borrowing too cheap to pass up.

    I prefer my bank robbers wear a mask and have bad teeth – not dressed in $3000 suits and drive limousines.

    • nobody.really says

      The way to avoid believing in fairy tales is to seek out, and cite, evidence.

      “Fannie and Freddie served the role of ‘market makers’ via their setting of acceptable (read: required) standards for loan origination and associated requirements. This TOLD the market what they should do….”

      Nice story.

      Of course, Levitin (Georgetown) and Wachter (U Penn/Wharton) also have a nice story, which they call “Explaining the Housing Bubble,” http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1669401 (2011). And their story comes with supporting data.

      In sum, the authors find that the bubble resulted from a “mortgage-finance supply glut as resulting from the failure of markets to price risk correctly due to the complexity, opacity, and heterogeneity of the unregulated private-label mortgage-backed securities (PLS) that began to dominate the market in 2004.” Thereafter Fannie Mae and Freddie Mac rapidly lost market share. Late in the game, their shareholders insisted that Fannie Mae and Freddie Mac fight back by lowering lending standards – but by then, the die had already been cast.

      Thus, contrary to your story, Fannie and Freddie were followers, not the leaders. And they were willing to follow the PLSs only because they had to meet shareholder demands – that is, because they were NOT purely government entities. In contrast, the wholly public FHA/Ginnie Mae, unaffected by shareholders, maintained their underwriting standards, and thus emerged from the financial crisis unscathed.

      “couple this with the substantial fines imposed by the Federales on Bank of America, Wells fargo and the threats of fines on other banks and it is clear that this was NOT an unregulated market.”

      Yup, which explains why Bank of America and Wells Fargo became insolvent.

      Oh, wait, they didn’t become insolvent. It was Lehman Brothers and Washington Mutual and Countrywide Financial and Merrill Lynch that became insolvent — financial institutions that had no duty to make any mortgage loans. Indeed, poor beleaguered Bank of America was so burdened by federal regulations that they had the wherewithal to BUY Countrywide and Merrill Lynch.

      (To be sure, Bank of America and Wells Fargo each accepted funds from the TARP program, as did petty much all of the major banks.)

      If you have a quote of Barney Frank browbeating Bank of America and Wells Fargo, please share. Otherwise, you’re simply documenting the fact that the heavily-regulated entities are the ones that survived the crash; it was the less regulated ones that collapsed.

      “The Fed has not done a very good job of managing the ‘business cycle’ precisely because it is a pretense that they know how!”

      Please remind us, during what era was the business cycle better?

      The National Bureau of Economic Research maintains records of the frequency of business cycle crashes since 1854: http://www.nber.org/cycles.html This shows that from 1945-2009 (the latest year with data), we’ve managed to delay crashes to almost 70 months on average, much longer than during any prior period.

      Fairy tales are nice. Data is better.

  4. gabe says

    Again, a nice fantasy! The following statement BEGS the question of why there was a glut and why risk was not priced properly – because the Federales mandated that lenders WOULD dole out money to those “disadvantaged” groups. thus, to comply, we end up with perverse incentives. That is the real issue.

    “In sum, the authors find that the bubble resulted from a “mortgage-finance supply glut as resulting from the failure of markets to price risk correctly due to the complexity, opacity, and heterogeneity of the unregulated private-label mortgage-backed securities (PLS) that began to dominate the market in 2004.” Thereafter Fannie Mae and Freddie Mac rapidly lost market share. Late in the game, their shareholders insisted that Fannie Mae and Freddie Mac fight back by lowering lending standards – but by then, the die had already been cast. ”

    Also it is not so easy to excuse Fannie and freddie as numerous analysts (even CBO types) informed and cautioned them against such practices.

    Also, the case can be made that since the Fed downcycles have been of longer duration than previous in our history.

    Oh and for when we had a better cycle – I will respond by asking, excluding the Great Depression (Oops, that also was under the watchful eye of the fed and its attempts to provide a soft landing for Britain) when have we had a worse one then the one we are currently undergoing.

    Have fun, hope you are not a coupon clipper! It gets pretty ugly when account costs are greater than the interest on your lifelong savings.

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