Tags: Fed | banks | president | political

Stanford, UC Berkeley Professors: Fed Is Too Tight With Banks it Regulates

By    |   Wednesday, 10 September 2014 10:37 AM

Political independence represented an important principle in the 1914 founding of the Federal Reserve.

"The problem [now] is that while the Fed is largely independent of politicians, it is intimately connected, and even answerable, to the financial institutions that it is supposed to regulate," Stephen Haber, a political science professor at Stanford, and Ross Levine, a business professor at the University of California, Berkeley, write in The Wall Street Journal.

"The Fed's founders understood that politicians had to be blocked from using monetary policy to juice the economy before elections."

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Each of the 12 regional Fed banks is subject to the supervision of a nine-member board of directors. Private banks select six of the directors, and the other three are often executives at financial institutions appointed by the Fed's Board of Governors.

"Fed presidents are also deeply tied to financial institutions," the professors say. For example, New York Fed President William Dudley was formerly chief U.S. economist at Goldman Sachs, and former New York Fed President Tim Geithner is now president of private-equity firm Warburg Pincus after serving as Treasury Secretary.

"Cozy bank-Fed relationships are especially important for financial regulation and crisis management," Haber and Levine write.

So what can be done?

The professors note that some reforms should be made.

"First, the tight links between the Fed and the financial-services industry could be weakened by reconsidering the number of Fed directors appointed by banks. Second, Fed officials should be required to agree to a waiting period — perhaps as long as five years — after leaving the Fed to take a position at a financial-services firm," they suggest.

"Third, there should be greater transparency and oversight of the Fed's role as a financial regulator. Congress should establish mechanisms — including a group of experts with the authority to demand information from the Fed and the capabilities to assess Fed performance.

"Such reforms will not be a panacea: They will not address the extensive reach of finance into the political process of drafting and implementing financial regulations. But they represent principled first steps," Haber and Levine argue.

Meanwhile, Paul McCulley, chief economist at Pimco, says that though the Fed wouldn't dare say so in public, it is in fact working hard to boost stock prices.

With the economy stuck in a liquidity trap, Fed policy can't "generate a revival of either increased demand for or supply of bank credit and upside action for prices and wages on Main Street," McCulley writes in his September commentary.

So unless fiscal policy steps in with stimulus, the Fed must "dance with Wall Street," he says.

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Political independence represented an important principle in the 1914 founding of the Federal Reserve.
Fed, banks, president, political
Wednesday, 10 September 2014 10:37 AM
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