classical economics
for analysis,  forecasting
and policy design

Fed Led Too Long
By Wayne Jett

On July 25, 2009, the Wall Street Journal published commentary by R. Glenn Hubbard, Hal Scott and John Thornton, who are, respectively, dean and professor of finance and economics at Columbia Business School, professor of International Finance at Harvard Law School, and chairman of the Brookings Institution. Their remarks entitled “The Fed Can Lead on Financial Supervision” were directed to evaluating the Obama administration’s recommendations for financial regulatory reform and to advising Congress regarding what should be done. My response to their commentary follows:

Thank you for stating your consensus on financial regulatory reform as the nation weathers its worst financial debacle since the Great Depression. Unfortunately, it is not Congress which is “utterly misguided,” as you charge, but your consensus.

You credit Fed chairman Bernanke and Treasury’s TARP $700 billion bailout for saving the U. S. financial system “from Armageddon.” What about the Fed’s role in inverting the yield curve in 2005-2007, raising the cost of credit to small business above market rates and skewing bank lending to precisely the large financial firms which brought on Armageddon with their ultra-leveraged risk-taking? What about Treasury’s (Paulson’s) bait-and-switch in persuading Congress to buy “troubled assets” from banks across the country, but then handing the money to Wall Street “friends of Hank” banks? TARP funds were used to fund mergers and acquisitions, a notable one in Pennsylvania and Ohio on the eve of federal elections, enabling favored banks to become even more “too large to fail.”

On what basis do you conclude that the Fed has expertise to “monitor and control future systemic risks” to the financial system? The Fed failed to monitor or control risks to its individual member banks as it was responsible for doing. Indeed, as the Fed has done consistently, the Fed performed as a private firm dominated by its Wall Street shareholders. The Fed refused to assist Bear Stearns by opening its discount window, but assisted J. P. Morgan Chase’s takeover of Bear with $55 billion and then opened the discount window to Bear’s surviving competitors. Throughout 2008 and early 2009, the Fed’s Bernanke and the New York Fed’s Geithner, so far as could be discerned, did more or less what Treasury’s (Goldman Sachs’) Paulson insisted they do.

Russian economist Anatole Kaletsky wrote that Paulson “misused” mark-to-market accounting rules to destroy shareholders of Fannie Mae and Lehman Bros., and that “everyone realised the world’s most powerful economic official did not know what he was doing” when Paulson testified to Congress in support of TARP on September 23, 2008. In my opinion, Kaletsky is too kind in treating Paulson as merely incompetent. If “everyone” knew of Paulson’s lack of credibility, where were each of you? Since you still support TARP even in its aftermath, presumably you were with Paulson.

Despite all this, your proposal of a U. S. Financial Services Authority deserves consideration and prompt action. Neither the SEC nor the CFTC served the public interests in 2008, as the price of crude oil was manipulated three times higher than market, crashing the world economy, and while rampant trading fraud in securities markets destroyed major firms and froze credit markets. First and foremost, the SEC must be stripped of its discretion to shield Wall Street’s big players from investigation – much less prosecution – for criminal violations of securities laws.

Regarding your objection to the Paul bill in the House requiring an audit of the Federal Reserve, you are anti-democratic in asserting that Congress may authorize this private central bank to manage the nation’s currency, but then cannot learn of any specific transactions or use of funds. If you are correct, I cannot think of a better argument for immediate abolition of the Fed. Short of abolition, at least Congress should impose a firm money rule to govern the dollar’s value so the middle class will be protected from continued looting of its capital. ~