An 89-page document entitled Financial Regulatory Reform, authored by the Department of the Treasury, outlines the steps the administration plans to take in order to close “gaps and weaknesses in the supervision and regulation of financial firms presented challenges to our government’s ability to monitor, prevent, or address risks as they built up in the system. No regulator saw its job as protecting the economy and financial system as a whole”. According to the document, government authority will be expanded in five areas.
The supervision and regulation of financial firms;
The comprehensive supervision of financial markets;
The protection of consumers and investors from financial abuse;
The provision to the government of additional tools “it needs to manage financial crises”; and
Raising international regulatory standards and to improve international cooperation.
By any definition this represents a large increase in the role of government over the financial markets. That is an avowed intent which its supporters believe is necessary to safeguard future growth and to prevent another recession. However, one reader of the Belmont Club thinks the proposal contains hidden dangers. The reader believes that unless we are careful, “financial regulatory reform” may lead to a loss of independence of the Federal Reserve.
From what I can see, this is a two-step gambit for a Executive and Legislative branch takeover of the Fed. The first step was taken this week: announce sweeping new reforms that significantly concentrate regulatory oversight in the Federal Reserve. Here are some of the bullet points from the Introduction section of the white paper:
• New authority for the Federal Reserve to supervise all firms that could pose a threat to financial stability, even those that do not own banks.
• Elimination of the federal thrift charter and other loopholes that allowed some depository institutions to avoid bank holding company regulation by the Federal Reserve.
• New authority for the Federal Reserve to oversee payment, clearing, and settlement systems.
At first blush, this looks like a major coup for the Fed, as it gives them broad influence over financial markets, including hedge funds and non-financial firms that have significant financial operations (e.g. GE). But the white paper also contains the following statements:
• A new Financial Services Oversight Council of financial regulators to identify emerging systemic risks and improve interagency cooperation. To help fill gaps in supervision, facilitate coordination of policy and resolution of disputes, and identify emerging risks in firms and market activities, this Council would include the heads of the principal federal financial regulators and would maintain a permanent staff at Treasury. [Note that this oversight extends to the Fed.]
• Revisions to the Federal Reserve’s emergency lending authority to improve accountability. In order to improve accountability in the use of other crisis tools, we also propose that the Federal Reserve Board receive prior written approval from the Secretary of the Treasury for emergency lending under its “unusual and exigent circumstances” authority.
These put the Fed more under the control of the President, as he appoints most members of the FSOC (actually all of them, except for the Fed Chairman), and the Secretary of the Treasury. But the big one is this:
The Federal Reserve, in consultation with Treasury and external experts, should propose recommendations by October 1, 2009 to better align its structure and governance with its authorities and responsibilities.
[The report goes on to say]
This report proposes a number of major changes to the formal powers and duties of the Federal Reserve System, including the addition of several new financial stability responsibilities and a reduction in its consumer protection role. These proposals would put into effect the biggest changes to the Federal Reserve’s authority in decades. For that reason, we propose a comprehensive review of the ways in which the structure and governance of the Federal Reserve System affect its ability to accomplish its existing and proposed functions. This review should include, among other things, the governance of the Federal Reserve Banks and the role of Reserve Bank boards in supervision and regulation. This review should be led by the Federal Reserve Board, but to promote a diversity of views within and without government, Treasury and a wide range of external experts should have substantial input into the review and resulting report. Once the report is issued, Treasury will consider the recommendations in the report and will propose any changes to the governance and structure of the Federal Reserve that are appropriate to improve its accountability and its capacity to achieve its statutory responsibilities.
Translation: the Treasury Department will propose changes to the governance structure of the Fed toward the end of 2009. This means that at a time when unemployment is likely in double-digits and the financial markets have stabilized, the Obama Administration will propose a change to the governance of the Fed. This is the second step of the gambit.
At this point, there will be strong pressure inflationary pressure, as the economy has found a bottom and demand for capital starts to rise. So the Fed, if it is to maintain its commitment to a stable money supply, will need to increase interest rates. The President and Congress will not want this to happen, as rising interest rates will mean a slower recovery and therefore slower job growth. This will be the perfect opportunity for the Administration to force a change in the way that regional Federal Reserve Bank Presidents (the core of the Fed’s governance) are chosen. My guess at the change: the President nominates Fed Bank Presidents, and Congress must approve. This will give the Executive and Legislative branches effective control over monetary policy.
So the gambit can be summarized thusly: I’m going to give you a lot more authority, but because you have all this authority I must control you.
If this were to occur, the dollar would collapse as foreign lenders (primarily other countries) sell dollars and buy other stuff (probably IMF SDRs [Special Drawing Rights]). You see, right now the Fed is the most trusted monetary entity in the world because its policy is basically set by professionals who are not controlled by politicians. This means that the FOMC can make decisions without requiring Congressional hearings or Presidential consent. The OODA loop is therefore tight, and the folks responsible are dedicated to maintaining monetary stability.
But if the dollar collapses, there would be a rapid rise in inflation, as commodity prices increase, and we’d enter a new period of stagflation. This would increase calls for fiscal stimulus to “put people back to work,” and it would make repayment of our massive deficits easier to pull off. Washington’s power over the economy would dramatically increase, and a lot of damage would be done.
The showdown is coming. I pray that our nation has the foresight to resist this power grab.
This is one interpretation of the possible outcomes inherent in “financial regulatory reform”. The reader’s main fear, as I see it, is the possibility that ‘financial regulatory reform’ will lock the Fed into the political goals of the administration. Thenceforth, the two will then be joined at the hip and the Fed will become a creature of the politicians. There has been a disturbing trend of late, highlighted by the firing of Inspectors General, to simultaneously concentrate power and reduce independent oversight. That is a dangerous combination of developments. And while not everyone may agree that an emasculation of the Fed is in the works, it is an issue that is important enough to merit a wide public policy debate. I hope the reader’s article can in some way, start the ball rolling.
Open thread.
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19 Comments
1. Insufficiently Sensitive:Such a concentration of power in the Executive branch – with the connivance of a Congress that is mostly joined at the hip with the President – is just a bit too much like the emergence of the Stalin who had saturated the Politburo with his placemen, and was then showing his hand as The Boss, who simply eliminated those of contrary opinion.
With the MSM already in place to play the role of Pravda, let’s hope for some more articulate guys like the writer above, and hope they have the ability to get the debate out in the open in sufficient volume to at least pierce the cheerleading of the MSM.
Jun 22, 2009 - 5:12 pm 2. njcommuter:Let us Hope, then, that this President and the Change he brings are as thoroughly discredited in the eyes of the general electorate as Nancy and Harry are in ours. Let us Hope then that the MSM becomes as jaded with him as the HuffPo crowd and the Kossacks.
Jun 22, 2009 - 6:04 pm 3. Hunt Johnsen:Would anybody care to recommend a good hedge against inflation?
Gold? Silver? Ammo? Back when I was drinking I though a still might be a really good investment as you could trade ’shine for anything else you needed and run your car on it as well.
Jun 22, 2009 - 6:36 pm 4. Dave the Kapampangan:Aloha
Govt. to Space Agency: “If you want funding, you had better re-do all your space equipment to be compatible with Russian equipment so we can keep former Soviet scientists gainfully employed.”
Space Agency: “But our costs will go through the roof if we do as you say!”
(Six months later….) Government: “Well, well. Looks like YOU are over budget. You obviously need more government supervision.”
————–
Govt. to banks: “I want you to make home loans and student loans to people who will probably never pay them back.”
Banks: “But it’ll destroy the banking system if we do as you say!”
(Six months later….) Government: “Well, well. Looks like YOU have nearly destroyed the banking system. You obviously need more government supervision.”
————–
Govt. to citizens: “I want you to turn in your weapons, so there will be no more crime.”
Banks: “But we’ll be defenseless if we do as you say!”
(Six months later….) Government: “Well, well. Looks like another gun-weilding wacko has attacked the now disarmed public. You obviously need more government supervision.”
————–
Parents and Schools to Government: “Can we go to a voucher system now, so the neighborhood kids can get a chance at good schools?”
Government: “No. All you need is more government supervision! And more! And still more! Welcome to America, and rejoice and sig heil to the creeping omnipotence of the STATE, where all problems will forever be solved by ceding power to your friendly Uncle Siegfried, bwahahaha!”
But seriously, folks. Ask the home schoolers. The government takes your money, and you end up solving the problem yourself. Given its stellar track record with social security, medicaid, medicare, and managing the national debt, is there any reason to believe that government should be managing the Fed?
Jun 22, 2009 - 6:54 pm 5. Blindman:“So the gambit can be summarized thusly: I’m going to give you a lot more authority, but because you have all this authority I must control you.”
The Fed has 2 charges. It is tasked with protecting the value of the currency and optimizing employment levels.
It now seems clear that there was a fairly large unregulated shadow banking system that was a leading risk taker in the ramping up of securitized debt instruments portfolios with their illiquid counter party guarantees consisting of credit default swaps. The selling of these instruments to the vast profit seeking pension plan pools yielded amazing irresistible commissions. This is where the profits to the shadow banks and market center banks came from. Everybody knew it couldn’t last but with apostolic righteousness they felt that if they didn’t take the profits lying in the road in front of them then they would be fired by their shareholders. Meantime they made gobs of money. They would look at each other and commiserate that there was no other choice. Their counter party would agree and say “No sh*t Sherlock, What else can we do?”
The amount of liquidity in that system was greater than or equal to the conventional banking system. It in effect forced the regulated banks to compete with them or lose the business that the banks had to have to have a viable business. This is somewhat a perverse enactment of the proposed public option in the health care final fantasy legislation currently in markup in congress.
It seems only fair that if you want the Fed to drive the car it should drive the whole car. It cannot be effective without that power. The notion though that one needs to enlarge the power of the fed may be misplaced. Not only is it likely to prove prone to the corrosive effects of special interests, it does not have the herd immunity critical for system stability that the political classes have developed (albeit imperfectly) to corruption over the many years of the republic.
The simple and least likely solution would be to get rid of the shadow banking system and put those forces and resources back into the real and tested banking system that we already have. Oh and by the way get rid of the true and primary cause of the securitization debacle which is both Fannie Mae and Freddie Mac. Even the slowest growing tumors given enough time will kill the patient John Maynard Keynes not withstanding.
Jun 22, 2009 - 7:16 pm 6. buddy larsen:Fannie Freddie, Cloward Piven, sister mother, mother sister
Jun 22, 2009 - 7:47 pm 7. GerryP:There have been a lot of conspiracy theories for a long time that the Federal Reserve has been a great problem and a destructive force. Part of that concern has been that the Fed is in private hands. What such theorists need to ask themselves, however, is whether it would not be even worse in government hands. Any conservative should see the answer to that.
There are really two basic issues here. First, should there be a Central Bank (the Fed) at all?
Second, if there is, should it be run by the government, or by experts from the private sector, independently?
Either way, there is huge potential for abuse and corruption. But given the historical record, government seems to outdo non-government every time when it comes to abuse and corruption. (Not to mention bloat, waste and incompetence.)
It seems clear to me that if we are going to have a central bank, the last entity to run it should be the government! Surely we have learned a few things about goverment-run enterprises by now.
Jun 22, 2009 - 8:26 pm 8. Leo Linbeck III:The Executive and Legislative branches already exert a fair amount of influence over monetary policy and the Fed. For instance, the President nominates, and the Senate confirms, the seven Board of Governors of the Fed, including the Chairman. But the terms of office are 14 years, their terms are staggered, and they are generally limited to one term. This greatly diminishes the influence politicians enjoy over their operations.
The 7 Fed Governors, together with 5 Presidents of the Regional Federal Reserve Bank, make up the key group that controls national monetary policy. The Regional Presidents are chosen by independent boards, themselves controlled by member banks. As professionals chosen by bankers, they exert a strong influence over monetary policy.
There are two main ways that governance could change, IMHO:
Because of the staggers, a POTUS will appoint at least two Governors; if the POTUS also can “hire and fire” Regional Presidents, they will gain effective control over FOMC policy. The second has the advantage of being sellable to the general public; it is easy to see how this change would be spun:
So what is the limit of the power of the Federal Government? Where do we draw the line? The Federal Reserve Bank is, to be sure, an imperfect institution. But it is also independent, and that is why it is a threat to Washington’s hegemony.
The other interesting question is: if we accept that there should be a limit – i.e. we have a conservative worldview – when do we know we’ve gone too far? At Enron, each step seemed perfectly reasonable and defensible – what begins as a perfectly legitimate transaction (a sale of assets to a third party) becomes a twisted, bizarre monstrosity (a sale of assets to an entity controlled by our CFO with a put back to us, so the CFO locks in huge profits for himself while helping us manage and inflate our earnings).
For the students of human nature here at the Belmont Club, a quiz:
Please show your work.
L3
Jun 22, 2009 - 8:38 pm 9. Robohobo:L3 = If the temp is turned up slowly enough, never.
The only thing that can save the Republic now is that the citizens realize that The 0bamanation has been turning up the heat too fast.
It is going to be ‘interesting’. Be glad you live in Texas.
Hunt @ 3: Ammo, that still (gives you good trade stuff), canned goods, land, non-hybrid seed are a good start.
Jun 22, 2009 - 9:37 pm 10. Unsk:If one reads the lefty blogs, both posters and commenters on the left never, ever differentiate between that financial regulation that is designed to limit fraud and abuse, and the kind of financial regulation that is designed to socially engineer. The left purposely commingles the two. So those who criticize those regulations that socially engineer will be hounded by the left as one who is lax on fraud and abuse.
This issue will be no different. The Left with the help of the State run media will again misinform and misdirect. We’ll surely be treated to yet another deceptive phony lying witch hunt aimed solely as discrediting those who want to bring some free market sanity to our regulatory system. Buraq’s and the left’s arguments are almost certainly going to accusatory in tone, deceptive , inflamatory, totally without redeeming value and spiteful.
I hope the populace finally wakes up. We are done if this thing passes; The marxist thugs will then control our whole financial system
Jun 22, 2009 - 9:56 pm 11. Brock:That’s odd. I thought it was Congress’ responsibility to be on the lookout for systemic risk.
Jun 23, 2009 - 6:04 am 12. Alvin:re: 3 inflation hedges– You might want to read a book called The Alpha Strategy by John Pugsley. It was published about 25 or 30 years ago during the last big inflation scare in the USA. It reviews economics in an intertaining fashion and basically concludes that the best anti-inflation strategy is to buy and stock-pile things you use like storable foods, toilet paper, even tires. Makes a lot of sense for many but obviously is quite limited if you live in an apartment. Also, if one is fortunate enough to have a lot of surplus capital it’s hard to invest it all in consumables. As I recall he covers precious metals, too, I think mainly for those with lots of excess capital.
Jun 23, 2009 - 7:04 am 13. Pseudo-Polymath » Blog Archive » Tuesday Highlights:[...] the Democrats work out how the government will have more influence and oversight over the fed … here’s a point as to why that’s a really bad idea. Remember they weren’t [...]
Jun 23, 2009 - 7:15 am 14. Stones Cry Out - If they keep silent… » Things Heard: e73v2:[...] the Democrats work out how the government will have more influence and oversight over the fed … here’s a point as to why that’s a really bad idea. Remember they weren’t [...]
Jun 23, 2009 - 7:16 am 15. buddy larsen:L3/8; again it’s “process vs results”.
Process being the left’s Trojan Horse (because no one can watch the watcher) the right is stuck with ‘results’ –which in the case of the Fed governance means we need good people –honest, patriotic, intelligent, public-spirited people, to populate the system.
This is an ancient problem, often in the past addressed via the institution of the eunuch. Dunno if that helps any.
brock/11; –right –we do already have all the regulatory levers we need and then some. What’s been missing is the will to make them work. Case in point, the naked shorting which has wrecked so much of the one thing investors need most –confidence in a non-rigged system. Already illegal, merely unenforced “by custom”. ‘Splain THAT for me wouldja?
Hint: the same people –i mean the same exact, nameable individuals –who enabled & operated the massive failure of the system are the very people who will enable & operate the “new” replacement system. We needs ta wakes up.
Jun 23, 2009 - 7:18 am 16. John Work:L3 @ 8: As always, you provide good information and what seems a likely scenario. As for we frogs:
“Double, double toil and trouble;
Fire burn, and cauldron bubble.”
sing the witches in MacBeth.
Hunt @ 3: Ammo would be good (if you can find any), but the still option might be even better.
Jun 23, 2009 - 7:25 am 17. M. Simon:At what temperature does a frog jump out of a hot kettle? At 100ºF? 200ºF? 211.9ºF?
What is the altitude and relative humidity?
Jun 23, 2009 - 5:40 pm 18. buddy larsen:http://market-ticker.denninger.net/
today’s entry “congress has no more excuses” takes apart the CDS and the OTC mkt. The “toxic asset” mess that AIG blew itself sky high with (Citi is next), and came back down as property of Uncle Sam. Good article, tho he doesn’t go into the history of the thing that grew, from the reg reforms of 2000 to the summer of 2007, from a few hundred million to sixty trillion.
The folks who put that trade together must’ve known what they were doing, ‘cuz they all got re-hired (after the Bush interregnum) to re-reorganize the financial universe yet again for yet another new administration.
Millions of newly-busted people should be screaming, but aren’t, their MSM –by acting as tho it covers the news –being far far far worse than nothing at all.
Jun 23, 2009 - 9:33 pm 19. buddy larsen:(from the wiki)
…Gensler spent 18 years at Goldman Sachs, making partner when he was 30, becoming head of the company’s fixed income and currency trading operations in Tokyo by the mid-’90s, and eventually the company’s co-head of finance.[3]
Subsequent to his time at the Treasury he acted as a Senior Adviser to Senator Paul Sarbanes, one of the authors of legislation that eventually became the Sarbanes-Oxley Act, designed to bring greater oversight to the accounting industry and reform of corporate governance.
As the Treasury Department’s undersecretary for domestic finance in the last two years of the Clinton administration, Gensler found himself in the position of overseeing policies in the areas of U.S. financial markets, debt management, financial services, and community development. Gensler advocated the passage of the Commodity Futures Modernization Act of 2000, which exempted credit default swaps and other derivatives from regulation. The Senate is expected to examine his views on derivatives regulation during the Senate confirmation hearings.[4]
In March 2009, Senator Bernie Sanders (I-VT) attempted to block his nomination to head the Commodity Futures Trading Commission. A statement from Sanders’ office said that Gensler “had worked with Sen. Phil Gramm and Alan Greenspan to exempt credit default swaps from regulation, which led to the collapse of AIG and has resulted in the largest taxpayer bailout in US history.” He also accused Gensler of working to deregulate electronic energy trading, which led to the downfall of Enron, and supporting the Gramm-Leach-Bliley Act, which allowed American banks to become “too big to fail.”[5]
Jun 23, 2009 - 10:54 pmSorry, comments for this entry are closed at this time.