Beware of Woolly-Minded Attacks on the Fed
The biggest threat may come from proposals to limit the central bank’s ability to act as a lender of last resort.
By Alan S. Blinder
Jan. 27, 2015 6:25 p.m. ET
Welcome to 2015. On the Chinese calendar, it will soon be the Year of the Sheep. On the financial calendar, it looks like the Year of the Fed. Let’s hope the Fed doesn’t get sheared.
As almost everyone knows, this year the Federal Reserve will start to “exit” from its hyper-expansionary monetary policies. But the Fed may also spend the year defending itself against a series of congressional attacks on its independence.
The barrage started on Jan. 12, when a seemingly innocuous provision was tucked into a piece of must-pass legislation, the Terrorism Risk Insurance Act, with no hearings, no congressional debate and, for the most part, no notice. The law now requires that the seven-member Federal Reserve Board include “at least 1 member with demonstrated primary experience working in or supervising community banks having less than $10,000,000,000 in total assets.’’
Now, there is nothing wrong with having a community banker on the Fed board; and President Obama ’s announced nominee, Allan Landon, seems well qualified. The problem is assigning board seats to specific constituencies. What about big bankers? Labor leaders? Home builders? Professors? Democrats? Republicans? As Fed Chair Janet Yellen explained at a congressional hearing in July, this could lead to “earmarking each seat for a particular kind of expertise.”
Yes, the new law could Balkanize and politicize the Fed. For example, what will happen when Democrats realize that virtually all community bankers are Republicans?
The first is the Federal Reserve Accountability and Transparency Act, a bill introduced by House Republicans that has little to do with the worthy goals in its title. The objectionable part of FRAT, as I’ve written in these pages, would require the Fed to adopt a mechanical rule for monetary policy—it strongly suggests a rule invented by economist John Taylor of Stanford University—and then justify any substantial departures from that rule to Congress. The political message is unmistakable: Depart from the Taylor rule at your peril.
As rules go, the Taylor rule is not a bad one. In normal times, it provides a useful benchmark against which monetary policy can be appraised. But what about abnormal times? When the economy departs from “the rules,” do we really want the Fed to stick with the Taylor rule out of fear of congressional browbeating?
The second proposal, called Audit the Fed, is an old standby that has been rejected by Congress several times. Don’t let the name fool you; this is not about accounting. The Fed’s books are audited already. The issue in Audit the Fed is whether Congress, probably via the Government Accountability Office, should “audit” the Fed’s monetary-policy decisions. Now, there’s a great idea: Let’s take an independent agency that has been performing well and have its decisions second-guessed by a branch of government that, shall we say, has not been performing well.
But the biggest threat to the Fed and the economy may come from proposals that would limit, perhaps severely, the central bank’s ability to act as lender of last resort in a financial crisis—something central banks have done for centuries.
Before 2010, Section 13(3) of the Federal Reserve Act gave the Fed carte blanche to lend “in unusual and exigent circumstances,” and the Fed made use of that broad authority in the financial crisis. Many of those emergency loans were political poison—think Bear Stearns or AIG. So, in writing Dodd-Frank, Congress clipped the Fed’s wings. Section 13(3) now bans loans to individual companies; emergency lending is limited to programs “with broad-based eligibility.”
That provision of Dodd-Frank was a mistake, but a small one. Small because, in a truly systemic crisis, many financial firms are likely to be in danger of collapsing and dragging the economy down with them. The Fed could still step in by lending to a group of companies.
But some of the Fed’s congressional critics remain unhappy because such crisis lending might save some financial giants from oblivion, making them “too big to fail.” True—sort of. First, can anyone imagine the Fed stopping a systemic crisis without saving—temporarily—at least some systemically important companies? And second, other parts of Dodd-Frank require that basket-case financial giants be liquidated, not saved, albeit in an orderly manner—that is, not like Lehman Brothers in 2008.
It’s hard to know how problematic these proposals will be without specific legislation. But, unless the restrictions are meaningless gestures, they must go beyond Dodd-Frank, which already stipulates that emergency loans not be made “to aid a failing financial company,” that there must be enough collateral to “protect taxpayers from losses,” that the Treasury secretary must approve and more. Several members of Congress, led by Sens. Elizabeth Warren (D., Mass.) and David Vitter (R., La.), wrote to Ms. Yellen last summer, expressing their displeasure at the way the Fed is interpreting these and other Dodd-Frank provisions.
Who knows what comes next? For those who believe it is important to have an independent central bank, empowered to do its job, the Year of the Fed looks scary indeed.
Mr. Blinder, a professor of economics and public affairs at Princeton University and former vice chairman of the Federal Reserve, is the author of “After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead” (Penguin, 2013)