Tags: Richardson | Fed | chairman | QE

Bloomberg Economist on the Future of Fed

Wednesday, 25 Sep 2013 02:26 PM

By Robert Feinberg

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Bloomberg senior economist Nela Richardson appeared on a segment of C-SPAN's Washington Journal on Sept. 17 to talk about the Federal Reserve in its 100th year. Richardson has a remarkable background, with an undergraduate degree from Indiana University, a master's from the University of Pennsylvania, a doctorate from the University of Maryland, having worked as an adjunct professor at John Hopkins, a resident at Harvard's Joint Center for Housing Studies and as an economist at the Commodity Futures Trading Commission and Freddie Mac.

In her interview and interaction with callers, she provided some useful insights, but also made some mistakes that should be corrected. Unfortunately, the interviewer forgot to ask Richardson about the full list of prospective chairmen of the Fed as set forth in the Financial Times.

At the outset, she described the Fed as "free from Congressional and political interference," except when it comes to picking the chairman. This is an example of useful insight, in the form of pointing out that the appointment is political, mixed with error in describing the Fed as otherwise free from political influence. This is an idealized vision that fails to hold up in reality.

She added that the Fed was formed in response to a series of financial panics, based on an "independent and decentralized" model that continues to this day. Again, this is the official version of what the Fed stands for, but the degrees of independence and decentralization have changed over time.

The Fed is supposed to fulfill what is known as a dual mandate to achieve a balance between price stability and full employment, and Richardson rightly pointed out that the Dodd-Frank Act added "financial stability" to the mandate. She chose not to speculate as to what additional duties and mandates the Fed has added, and most economists follow this course, but the interview would have been more useful if she had talked about the pronounced "mission creep" that has accelerated to something more like a sprint or a relay race over the past few decades.

However, she did introduce the topic of so-called quantitative easing (QE), the extraordinary measures the Fed adopted after the 2008 crisis episode in order to forestall a stall that Chairman Ben Bernanke feared might overtake the economy as it did in the Great Depression.

In further discussion of the Fed's creeping mandate, Richardson rightly referred to its function as "lender of last resort" to the banking system, but then asserted that the Fed is "maniacally" dedicated to its mandate, a notion that is refuted by the mere statement of the growing list of functions the Fed has accreted over its first century.

The topic now is supposed to be when to withdraw or taper QE, and while this was not known on the 17, the Fed has still not acted. I have always questioned the Fed's resolve and even ability of the Fed to withdraw its intervention as promised, but rather, and cynically, suspect that the Fed will extend its intervention to other, riskier assets, such as stocks. A useful insight, and one that is commonly mentioned, is that there is a tradeoff between the components of the dual mandate, at least in the short run, because at any given time, actions to restrain inflation can slow the economy until the market adjusts to a lower-inflation environment.

In explaining the leadership structure of the Fed, Richardson misstated the governing entity as the "Federal Open Markets (sic) Committee," rather than the Board of Governors, and this would have led viewers to think there are seven members of the FOMC, which, as she said, sets the Federal Funds Rate (FFR), the wholesale rate at which banks borrow from each other.

Actually the FOMC has 19 members, composed of the seven members of the Board of Governors and the 12 presidents of the regional Federal Reserve banks. It's not her fault, but things get really complicated, because some Fed presidents rotate more frequently than others do into voting status. It also would have been helpful if she had pointed out that while there is one vacancy on the Board now, another is due to occur in January, when the term of Governor Jerome Powell expires. (I would point out that when this occurs, it will facilitate filling the vacancies in the manner former Rep. Barney Frank, D-Mass., criticized, by appointing one representative from each party, perhaps even one staff member of the Senate Banking Committee from each party, so as to speed confirmation of the appointees.) Later she referred to four votes controlling Fed policy, a reference I admit I could not follow.

When a caller asked whether Richardson was familiar with the novel (sic) "Creature from Jekyll Island," a 1964 chronicle by G. Edward Griffin of the establishment and workings of the Fed by a group of Wall Street insiders who met there secretly, she said she hadn't heard of it, which was a bit surprising. Wikipedia points out that Griffin has been a proponent of the quack cancer treatment laetrile and of a controversial theory regarding the location of Noah's Ark.

Turning to a discussion of the qualities a new chairman should bring to the job, Richardson helpfully cited a book by David and Christina Romer that points to experience with fiscal policy and having worked in the private sector as qualities that an appointee should possess.

She called Larry Summers a "lightning rod" and opined that his withdrawal from consideration reassured the most liberal Democrats, some of whom blame Summers for deregulation of financial institution during the Clinton years that critics blame for contributing to the 2008 episode. She allowed that Summers had pledged to be a strong regulator if appointed.

Speaking of Fed Vice Chairman Janet Yellen, Richardson accurate described her as "the frontrunner unless someone else sneaks up on her," and she noted that Yellen also has also promised to be a strong regulator.

The only other candidate discussed in the interview was former Vice Chairman Donald Kohn, who Richardson observed has 40 years of experience in the Fed system, and she might have added is extremely unlikely to be appointed because he is a technocrat with no political base.

In response to a couple callers who advocated a restoration of the Glass-Steagall Act, the Depression-era law that for a time prevented bank holding companies from engaging in both commercial and investment banking together, Richardson articulated the pro-bank position that a mingling investment and retail banking activities is necessary in order to facilitate securitization of financial assets such as mortgages.

In other remarks, Richardson confused the issue of how the Fed is funded when he asserted that it is funded by the member banks at no cost to taxpayers, whereas it would have been more accurate to say that the Fed funds itself through the proceeds of the government securities it holds and returns net income from the portfolio to the Treasury. Thus, any diminution in these earnings is costly to taxpayers. She accurately stated that such a result could occur if a rise in interest rates causes a loss in the value of securities the Fed still holds at the time.

As the interview wound down, Richardson gave crisp accurate answers to callers as she frankly admitted that the Fed, in effect, "prints" money in order to purchase $85 billion Treasury and agency securities to effect the policy of QE, acknowledged that the largest banks, including JPMorgan Chase and Goldman Sachs have tremendous exposure to the European Union, and expressed support for imposition of higher capital requirements on the "too big to fail" banks.

In sum, the operations and governance of the Fed are mind-bendingly complex, becoming more so all the time, and the Wall Street firms that control this enterprise seem to benefit from the very complexity and very much want it to continue, even as the scale and complexity of the too big to fail banks themselves has grown since the 2008 episode of the ongoing financial crisis.

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