The Federal Reserve Doesn't Work -- Time to Drastically Change It
Our Federal Reserve doesn’t work. Progressives have to get out in the fight to change it before Sarah Palin claims victory.
“We probably know more about tribes in the Amazon jungle than we do about the real nature of power in the United States. Neither political science, nor history, nor economics do very well on this.” - Tom Ferguson
Something new is happening around the contours of monetary policy. It’s becoming part of our popular political landscape. We saw this a few weeks ago, when Sarah Palin injected into the 2012 presidential race the idea of fundamentally reorganizing the Federal Reserve’s mandate. Republican Mike Pence, Senator Richard Shelby, and a host of other Republicans have jumped on this concept, and there will soon be legislation introduced to make this happen.
Beyond Republican politicians, the public is beginning to rethink our monetary order. A YouTube video on quantitative easing has over 3 million views. The video slams the Fed for missing the dotcom bubble, the subprime crisis, for being fundamentally undemocratic and unaccountable, and for being engaged in collusive dealings with Goldman Sachs. Financial blogs and CNBC discuss the Fed, and its associated characters, with deep insight and passion. And Bernanke drew 30 no votes in his confirmation hearing in 2009, the most ever for such a position, just four years after drawing almost none. The market nearly crashed on the possibility that Bernanke’s nomination would fail before the White House stepped up aggressive lobbying efforts. On the left, the last few years saw a remarkable grassroots coalition of economists and activists to bring transparency to the central bank, joining a long-sought libertarian crusade. I was a staffer for Rep. Alan Grayson, who was working with that coalition to require an independent audit of the Federal Reserve. Tomorrow, because of provisions put into Dodd-Frank by Senator Bernie Sanders and Congressmen Grayson and Ron Paul, the Federal Reserve will release details of its 2007-2010 emergency loans to the web.
This network of politicians, advocates, and bloggers will go to town on whatever revelations come out of that. (Although the Fed obnoxiously put its Maiden Lane disclosures in a non-copy or printable PDF format, so we’ll see how easy they make it to get this info.) The defenders of technocracy are out in force as well. Paul Krugman is defending the institution, if not every decision. The Democratic partisan class is going after right-wing Fed critics, while more liberal independents are pointing to the Fed in the 1940s and the Reconstruction Finance Corporation as a very different monetary model. Not since the populist movement of the 1890s has there been this much discussion of monetary structures among the public, and so much dissent about how money is created and circulated throughout the economy. It’s happening for a reason. The public is now paying attention to finance. We ran a focus group in Orlando last year, and one of the surprising conclusions was that nearly every independent voter knew who Ben Bernanke was. People don’t like the structure of our financial oligarchy, and they are talking about it. Even the deficit hysteria and the Fannie/Freddie GSE fights are a function of this monetary debate.
It is good that this debate is happening. It means that we will be able to examine the real power structure of the American order, rather than the minor food fights allowable in our current political system. This will bring deep disagreements, profound ones, but also remarkable possibility. Modern American industrial policy is to push capital into housing, move manufacturing abroad, build a massive defense establishment, and maintain an oligarchic financial sector. This system isn’t a structural inevitability. People built it, and people are unbuilding it. People with names, motivations, and reputations. People like us, and like Sarah Palin.
In 1989, Bill Greider published a remarkable book called “The Secrets of the Temple: How the Federal Reserve Runs the Country” in which he described how Fed officials were the real decision makers in the American political order. Shielded by the argument of ‘political independence’, most politicians wouldn’t and still won’t dare interfere with the workings of our economic structure, even though the Constitution clearly mandates that the monetary system is the province of Congress. The dramatic and overt coordination of this ‘independent’ central bank with the executive branch and the banking sector, and its flouting of Congressional and public scrutiny, have removed its institutional legitimacy.
Like most American institutions, the Fed has shrouded itself in myth, with self-serving officials discussing the immaculate design of the central bank as untouchable, secretive, an autocratic and technocratic adult in the world of democratic children. But the Fed, and specifically the people who run it, are responsible for declining wages, for de-industrialization, for bubbles, and for the systemic corruption of American capital markets. Take this passage from Greider’s masterpiece, on the inflation battles of the early 1980s.
“When White House officials congratulated themselves on how swiftly inflation was declining, Volcker pulled out his card on union wages and warned them not to be too optimistic. Until labor got the message and surrendered on its wage demands, the underlying rate of inflation would continue to push prices upward — and collide with the stringent reality imposed by the Fed’s money policy.”
Here was the Federal Reserve Chair, a Democrat, carrying around union wage stats in his pocket so he would know whether he was driving worker pay down fast enough. If you want to understand the poverty of the financial reform debate, that Volcker was ‘the hero’ of the reform side should illustrate it.
On a basic level, the Federal Reserve has two jobs. One is to maintain price stability, and the other is to maintain maximum employment. This ‘dual mandate’ comes from debates in the 1970s about full employment, and was part of the Humphrey Hawkins legislation that President Carter watered down from its original liberal origins. While the Fed ostensibly has to care about full employment, Carter made sure this would be more of a guideline, and it is quite obvious to anyone who pays attention to FOMC minutes that most Fed officials don’t take it seriously. Nevertheless, the Fed has a bunch of tools to accomplish these goals. It regulates the money supply through its balance sheet and a variety of market interventions, it maintains the payments and clearing system, and it regulates banks. It also has a number of consumer protection responsibilities, and has emergency lending authority that was radically expanded by Wall Street super-lawyer Rodgin Cohen in 1991 through a very subtle secretive maneuver.
Structurally, the Fed is a two-part system, with a Board of Governors in DC and Reserve Banks that sit in 12 separate regions of the country that represented roughly equivalent sectors of the economy in 1913. The Board of Governors has 7 members, each of whom can have one 14-year term, and a Chairman who has a four year term. These members are appointed by the President and confirmed by the Senate. Monetary policy is set through the Federal Open Market Committee, which has members from both the board and the Reserve banks. If you ever want to see how the country is actually run, read the transcripts of FOMC meetings, which are released on a five year lag (they used to be shredded as a matter of course). It is stunning to read how Reserve bank presidents basically talk to WalMart and high-end headhunter firms to find out how their regional economy is doing, and then set monetary policy. It’s also crazy that we still do not know what the FOMC was saying from 2005 onward, during the height of the mortgage boom and bust. All of this is secret, and very much open to subpoena for some enterprising politician. (It is one of my great disappointments that neither the Democratic House or Senate tried to get these transcripts, given that we know that Alan Greenspan was muffling dissent on the housing bubble in 2004, the last released transcript.)
The Reserve Banks are quasi-public and quasi-private entities owned by member banks. The New York Fed, for instance, pays dividends to JP Morgan, and has a .org web address. The Reserve banks are governed by Boards of Directors that are drawn mostly from the banking sectors of their regions, as well as large companies and the occasional union leader or university president. The Fed also has a large research staff and funds most macro-economic monetary policy research. It is uncommon to find ‘credible’ economists in monetary policy who have no financial ties to the Federal Reserve banks. The Fed is actually one point of contention between the right-wing billionaire Koch family and the Ron Paul libertarians; the Kochs are supportive of Federal Reserve-tied scholars, and Paul’s people are not (the Palin Tea Party had no involvement in the Audit the Fed fight, the Ron Paul Tea Party was the driving force on the right for that legislation).
This structure is the result of a political compromise in its inception, a holdover from the Wall Street-populist fights of the 1890s, the financial panic of 1907, as well as legislative shifts over 90 years. It is a deeply corrupt and indefensible system rife with conflicts of interest. The Reserve banks conduct a good amount of the regulatory work in our banking system. Their boards are staffed with bank leaders, and the presidents of the Reserve banks are actually hired by these bankers. Reserve banks even pay dividends to their bank members (attention Congresscritters who want to find a pay-for!). This ‘I’m a dessert topping and a floor cleaner’ identity allows Reserve banks — particularly the NY Fed — to intimidate courts and aide its allies on Wall Street. Additionally, the Reserve banks aren’t subject to the same government policies regarding Federal wages, so they can pay higher wages and give lucrative and prestigious consulting contracts to economists. In one hearing in the 1960s, a Reserve Bank was busted for buying thousands of ping pong balls. That lack of accountability, while silly, was and is still the norm.
The ambiguous identity is the reason the Fed was able to bureaucratically box out the FDIC as a center of intellectual gravitas. It also leads to overt corruption. Jamie Dimon, for instance, was on the board of the New York Fed when JPMorgan was negotiating with the New York Fed to buy Bear Stearns. Pete Peterson is a former New York Fed President, and hired Tim Geithner to be the New York Fed, who he is now presumably pushing to cut entitlements. Steven Friedman was on the NY Fed board, buying Goldman stock at the same time.
The list of failures goes on and on. But fundamentally, it is not corruption that is at the heart of the problem for this Fed system, it is a lack of democratic accountability. The Fed failed to stop the S&L crisis, the dotcom boom and bust, and the mortgage boom and bust, and shoveled money to AIG with an overtly disdainful approach to the public. Despite the best efforts of Fed allies, the center cannot hold. During Dodd-Frank, Chris Dodd and Barney Frank tried their best to protect the Federal Reserve, lavishing praise on Bernanke, and ultimately blocking the move to make the New York Fed president an appointed position. They did nothing about the egregious 14-year term, the banks appointing their own regulators, the dividends that go directly from the Reserve banks to private banks, the lack of ethics restrictions and pay scale restrictions, or the corruption of the macro-economics profession at the heart of the Federal Reserve’s research imperatives. Frank did not legislate out of malice. Indeed, he often expressed respect for democratic input into the legislative process, insisting, for instance, that the conference committee be televised. But ideologically, Frank took a Reagan-era liberal view that the goal of the banking system was to provide housing for the poor while protecting consumers’ rights. The rest of the capital markets structure was, as he put it in one caucus meeting, “rich people fighting other rich people.”
The new intellectual order dismisses this attitude as small bore. Institutionally, the environment has changed for the Fed and its traditional allies. Whereas at the beginning of the financial panic in 2007-2008, the Fed was a sole provider of expertise and credibility on finance to the political class, by 2010, the new financial blogosphere destroyed the Fed’s mythic stature. It is common for staffers to get more and better information from blogs, and for hearings to be driven by the conversation online, than from the Congressional liaison group at the Fed. Read this remarkable Q&A between Ben Bernanke and Senator Bunning during Bernanke’s confirmation hearing, which was a series of questions inserted into the record, questions largely drawn from bloggers. The public has changed its appetite as well. This YouTube clip of Elizabeth Coleman, the Inspector General of the Fed, was my boss’s most successful hearing appearance, and possibly the most consequential hearing put on YouTube, ever:
Over 3 million people have now seen this official say that she wasn’t tracking where trillions of dollars have gone. I prepped Rep. Grayson for that hearing, and I used materials from the blogs to do it. Many members watched this hearing on YouTube and signed on to the bill to audit the Fed as a result. And so tomorrow, we are going to get a peek at the Fed’s emergency lending activities from 2007-2010 because of this legislative activity. Even before that, though, the Fed has become far more open and responsive to requests for information. We’ve already seen, via Maiden Lane disclosures, that the Fed has been lending money to random companies, like the Red Roof Inn, and buying up lots of toxic crap. We’re going to see a whole lot more. The conversation is no longer in the hands of the bankers.
This is a tremendous step forward. Of the many castle walls the Fed used to keep the rabble out, secrecy and complexity were critical. The Fed couldn’t keep its dealings secret, and financial bloggers are constantly explaining, explaining, and explaining. Those walls have fallen. A lack of public debate was another. That too has fallen. A monopoly of public information dissemination, via personal contacts between bankers and outlets like the Washington Post (whose owner in the 1930s was Hoover’s Federal Reserve Chairman), has broken down as well through internet communities. Gradually, a new generation of politicians is gaining the confidence that the people themselves through their elected representatives should be making critical decisions about economic efficiency and banking. The Fed is adapting to these changes, building up its communication staff and doing town hall-style meetings. Bernanke is on TV all the time, a far cry from the days when the Federal Reserve head simply refused to even brief Congress. In some ways, the hardest part of the fight is generating public debate, but that has been accomplished. The structure of our monetary system is now up for grabs.
As we move forward in this debate, it is important to understand that Sarah Palin is coming from a tradition genuinely rooted in American economic debates, from the era of the late 19th century, when Wall Street came together to finance railroad mega-corporations. Her argument is one against the mutability of money; she rejects the idea that money is a political object, because that implies that it is collective decision making that determines property values and ultimately the social hierarchy. She believes in a natural and fixed social hierarchy, which is a very conservative idea deeply held by the business class. Palin is using the lack of legitimacy of the modern Fed, the failed technocratic screw-ups and the elitist tendencies, to push for the equivalent of a societal debtor’s prison. She is speaking for creditors, and many of the conservative forces within the Federal Reserve agree with her. It is important to understand that reflexively defending the Federal Reserve, which is what the Democratic establishment is doing, is a foolish and anti-populist attempt to pretend that the Fed is a legitimate decision making body. It isn’t. It is powerful, but not legitimate.
Liberals must move beyond our consumer-driven approach and think about reform of the credit system and of the monetary order, as Elizabeth Warren has done through her remarkable tenure on the Congressional Oversight Panel. The basic problem is the one that poet and economist Jane D’Arista puts forward in her 1991 paper No More Bank Bailouts. (And yes, she wrote that in 1991, so it is worth listening to her.) The link between the Federal Reserve and the ‘real economy’ is broken. When banks were the main conduit between the financial world and economic activity, translating savings into investment, the Fed could manipulate the economy by manipulating the banking sector. But now that shadow banks dominate our credit markets, and the Fed has allowed hot money to take over monetary policy, the Fed’s tools just don’t work. That’s why quantitative easing is foolish. We must dispatch with the ridiculous notion that pushing hundreds of billions of dollars into a broken banking system will have useful consequences.
Instead, let’s recognize that the Fed doesn’t fulfill either part of its mandate, and work toward a better and more plausible system of monetary stability. That’s not a long-term process, it’s a constant process. D’Arista argues that the Fed must connect itself to the shadow banking system and force credit to flow. This necessarily implies important changes in how the Fed interacts with financial services firms and entities. To give some idea of what this might look like, at least conceptually, Timothy Canova paints the portrait of a more democratic Federal Reserve financing the government debt during World War II. Cooperating with a phalanx of institutions, such as the Reconstruction Finance Corporation, and government boards that directed wartime rationing, the Fed was able to bring unemployment down to 1% and dramatically equalize economic opportunity and wealth building for the middle class. Another possible conceptual framework, though one that wouldn’t work today for obvious reasons, is the subtreasury plan put forward in the 1890s by the Populists, which would tie the monetary supply to real economic activity — in that era, agricultural output. I’m not sure how to tie intrinsically worthwhile economic output to the growth of the money supply, but it should be quite obvious that growing money to help credit default swap traders is a deeply corrupt way to think about how we as a society should define money.
Reform also requires what Ed Kane, a scholar at Boston College, has tackled, which is regulatory capture and growing a new cadre of publicly-minded policy makers and regulators. One of the biggest problems at the Fed is that its people simply do not work in the public’s interest, and see their goal as preserving the existing secretive banking structure. I found this to be true in my limited dealings with the Fed. At one point, I was trying to understand why the Fed granted Goldman Sachs an exemption from regulatory scrutiny as a bank holding company. The examiners and Goldman’s lobbyist were both happy to help me understand that I needn’t worry. When I mentioned that my boss was going to send a letter on the matter (it’s here, as well as the response from the Fed), both Goldman and the Fed examiner’s responses were the same. They turned hostile, and whined, ‘Can’t we handle this privately?’ The Fed examiner told me that he would not be able to give me good information if he was forced to work on a public response on the matter.
Leaving aside whether the Fed made a good decision on that particular regulatory decision, this is no way to run a legitimate institution in a democratic society. With a loss of legitimacy comes a lack of public trust and a vulnerability to any form of critic. The Fed is now less respected than the IRS. And so Sarah Palin has her opening, as do the conservative hard money creditor interests. Liberals should stop their love affair with conservative technocratic myths of monetary independence, and cease seeing this Federal Reserve as a legitimate actor. At the very least, we need to begin noticing that these people do in fact run the country, and should not. We must also begin to internalize the new forces of openness and rethink how a monetary system can function in an internet-enabled society. This will require thinking about Fed 2.0 from the perspective of the social web, as well as building upon the increase in transparency being forced on governing elites by such groups as Wikileaks. The top-down backroom system just won’t work if it relies on retaining secrets between Bank of America and the Fed that a third party or a court can release. The Fed can’t print its way out of a public that has lost faith in the banking system and the dollar. If we rethink money creation properly, however, we will be able to remove money creation from the hands of the oligarchs, and strike deeply at the uncompetitive nature of the American political economy. I do not know how to do this, but it is possible.
Tomorrow, we’re going to see some of what the Fed did from 2007-2010. And there will be ample justifications for why the Fed needed to do what it did, just as the Treasury keeps talking about how TARP made money. But the Fed gave $13 billion to Goldman Sachs through AIG, a direct transfer of $80 from every working American to the employees of Goldman Sachs. We’re soon going to find out who else got our money. And this disclosure, and the accompanying political debate over the monetary order, is the beginning of changing the way we think about money itself.
And with that, here’s the new law and the disclosures it forces:
From p. 754 of Dodd-Frank:
(c) PUBLICATION OF BOARD ACTIONS.—Notwithstanding any other provision of law, the Board of Governors shall publish on its website, not later than December 1, 2010, with respect to all loans and other financial assistance provided during the period beginning on December 1, 2007 and ending on the date of enactment of this Act under the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, the Term Asset-Backed Securities Loan Facility, the Primary Dealer Credit Facility, the Commercial Paper Funding Facility, the Term Securities Lending Facility, the Term Auction Facility, Maiden Lane, Maiden Lane II, Maiden Lane III, the agency Mortgage-Backed Securities pro- gram, foreign currency liquidity swap lines, and any other program created as a result of section 13(3) of the Federal Reserve Act
(as so designated by this title)— (1) the identity of each business, individual, entity, or for-
eign central bank to which the Board of Governors or a Federal reserve bank has provided such assistance;
(2) the type of financial assistance provided to that busi- ness, individual, entity, or foreign central bank;
(3) the value or amount of that financial assistance; (4) the date on which the financial assistance was provided; (5) the specific terms of any repayment expected, including
the repayment time period, interest charges, collateral, limita- tions on executive compensation or dividends, and other mate- rial terms; and
(6) the specific rationale for each such facility or program