In the debate over the economic crisis, there are a group of populists who believe the U.S. central-banking system is in the biggest bind of its life. Some of these critics object that the Federal Reserve is acting too slowly to curb inflation and is too quick to pull support from the zombie-like housing market. They complain that the central bank's $2.3 trillion balance sheet is overstuffed with bad loans designed to save Wall Street from facing the consequences of its actions. They say the Fed has made large mistakes in its oversight of big banks and has been too slow to push the break-up of these firms that could endanger our economy if they fail.
Here's the thing: This group of critics draw their paychecks from the same place from which they dissent. They are the 12 regional presidents of the Fed"”based in cities like Atlanta, Kansas City, and St. Louis"”and they represent the secretive institution's main link with the world beyond Wall Street and Washington. As conceived by the creators of the Fed, the regional presidents are its populist conscience"”and owe nothing to headquarters, Congress, or big banks"”although they can't make much policy in their five-year terms. And these officials are commanding more attention following a slavish media response during the financial crisis. But the Fed ignores their views at its own peril. The central bank has become almost inconceivably powerful and unaccountable as the architect of trillion-dollar bailouts. It is arguing for more supervisory power but has yet to explain its significant failings as a regulator. So its old secrecy won't suffice anymore.
This growing reality of gadfly versus establishment would seem to call for a political showdown. Instead, it's more of a political massacre. The main Fed is moving toward a model of running almost all of the financial system from Washington. And pending reform legislation proposed by Sen. Chris Dodd seeks to strip the regional presidents of their ability to supervise small banks and hand that authority to the FDIC. This would make the regional presidents figureheads"”a development that University of Oregon economics professor Mark Thoma says would be a loss to the public sphere. They might still have opinions, but without the ability to see how local banks operate daily, those opinions won't matter as much. Kauffman Foundation vice president of research and policy Dr. Robert Litan notes that the Fed would get less candid advice. The regional presidents act as informal checks and balances on the bank's policy statements.
So how much does this matter? It depends on the issue. The Fed's regional presidents made no impact at all when they debated the fate of its controversial program to buy $1.4 trillion of toxic securities from Fannie Mae (FNM) and Freddie Mac (FRE). Some argued for an extension of the scheme, but others advocated a fast reduction. The program appeared to be an important backbone of the housing and stock markets, but there have been no dire crashes since the program ended two weeks ago, which renders moot the views of both groups.
Such disagreements can be picayune, but many speak to major structural problems with the Fed and financial system, which makes them worth listening to. The loudest debate within the Fed is academic bickering about the right time to raise interest rates, and whether that will lead to inflation that could impede the economic recovery. Mostly this is a noisy but not a big issue; everyone agrees the Fed will raise interest rates, and the proposed timeframes don't differ by all that much. The most interesting concerns raised by the regional presidents are the alarms about the deeper issue: the fate of the economy as it responds to the Fed's ministrations. William Dudley, the president of the powerful New York Fed, has warned that America's heavy public debt may lead us into a national crisis and take away our control over our own interest rates if we don't find a fast plan to reduce our borrowing. Dudley also advocated a rethink of the Fed's role in monetary policy, arguing that the central bank should play a major role in curbing asset bubbles.
And others have gone even further. Kansas City Fed president Thomas Hoenig has called for a redesign of the entire U.S. financial system. He maintains that the Fed is supporting the profits of big banks, that instead those banks should be broken up. Those are the kinds of bold statements that the public is unlikely to get from other authoritative voices at the central Fed or in Washington, as legislators are too busy pushing financial reform legislation through Congress.
In the end, however, the regional presidents are likely to lose their power to the FDIC or the central Fed, which is evolving into a political entity replete with the savvy maneuverer Ben Bernanke at its helm. "I feel sorry for the bank presidents," said Chris Whalen, co-founder of consulting firm Institutional Risk Analytics. "They are in a traditional sense raising the right issues, but we've gone so beyond that in the Fed's capture by both banks and Congress that the whole thing's politicized now." The only power the regional presidents have is to bang some drums. But even that could make a difference to debate"”in an era when secretive bailouts can be designed by a few power brokers with access to the money of millions of taxpayers.
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