Sunday, August 1, 2010

Why the Fed Isn't Doing More

I've suspected this for a few months now, but Dallas Fed president Richard Fisher's recent speech — which Paul Krugman takes apart here — may provide some actual evidence to back up my suspicions. One big question has been why the Fed doesn't seem willing to do more to stimulate the economy, even in the face of persistently high unemployment and looming deflation. Krugman has suggested that the Fed is afraid to try something unorthodox because no one knows how well it would work, and failing would be very embarrassing for the Fed. I think that's part of the story.

But I also suspect that the Fed is reluctant to do more because the last time they went out on a limb and took extraordinary/unorthodox actions — bailing out AIG, establishing currency swap lines, supporting the money market funds — they were eventually savaged by politicians and the press for those actions. (And, mind you, the multiple investigations into the AIG bailout have turned up nothing legitimately untoward.) Even though the Fed was right to do those things, and they undoubtedly helped stave off a complete financial meltdown, grandstanding politicians and commentators badly misrepresented the Fed's actions in a (partially successful) effort to "rein in" the Fed's authority and autonomy. Reining in the Fed's ability to undertake extraordinary actions during a crisis became an explicit goal of both Republicans and Progressives during the financial reform debate.

If this is the reaction the Fed can expect when its extraordinary/unorthodox actions work, who knows what would happen if the Fed tried something unorthodox and failed. And I think this scares the Fed. They don't want to establish any unorthodox programs, for fear that politicians eager to ride a wave of populist sentiment will make another run at the Fed's authority and independence (or even the Fed's existence).

Just look at this passage from Richard Fisher's speech:

[W]e at the Fed must continue to comport ourselves in a manner that exorcises any lingering worries about our willingness to brook any political interference with our commitment to fostering price stability and maximum sustainable employment. We delivered on our duty to restore liquidity to the commercial paper, asset-backed securities, interbank lending and other markets. We then closed out all of our extraordinary liquidity facilities, doing so without costing the taxpayer a dime (imagine that: a government agency that closes programs after they have outlived their usefulness!). We have worked hard to earn the respect of the marketplace and of the nation, and we dare not risk it at a time when there is so much uncertainty elsewhere.
Translation: our earlier extraordinary actions, while successful, led to a good deal of threatened political interference, and we "dare not risk" raising the ire of populists in Congress again.

Of course, I don't think this justifies the Fed's inaction — what's the point of having the independence they're so jealously guarding if they're not going to actually use it? Politicians are always going to say idiotic things, and populists are always going to claim that the Fed is in bed with the big banks. But if the mere threat of "political interference" is enough to circumscribe Fed policy, then is the Fed really "independent" in the first place?

15 comments:

Anal_ said...

The Fed shouldn't be afraid of "extraordinary" (or whatever you want to call 'em) actions, because the criticism of AIG, for example, was that they completely shat the bed in the execution of said actions; just read the SIGTARP and other reports.

The take-away should be that if the Fed is to take such actions, they need to 1. grow a pair, 2. not jump to conclusions/take hasty and poorly (if at all) thought-out actions.

Roger said...

I must have missed something. Who criticized the Fed for the AIG bailout? I thought that was a Treasury thing that Paulson was blamed for. What did the Fed have to do with AIG?

Anonymous said...

Roger,
The AIG bailout was through the NY fed not the treasury. That is why Geithner got so much heat because he was the head of the NY fed during the AIG bailout.

Absalon said...

Saving the money market funds may well have saved the country. Have people forgotten or never knew how bad things were in the fall of 2008?

Anonymous said...

Oh, come on. Please. We need the Fed to use its powers to stimulate to disaster zone that is the balance sheets of our major banks. The Fed needs to buy additional trillions of dollars of additional toxic waste as full price and they need to do it outside the view of congress and the public.

A bunch of coke-snorting frat boys made some really BIG stupid bets with our money and paid themselves obscenely for the privilege. And now the taxpayer gets to foot the bill. But we shouldn't be able to see the invoice.

These guys made some really stupid bets and free market principles demand that they take a loss.

The government could guarantee money market funds without guaranteeing AIG's derivative contracts. Don't confuse the issue here.

tz said...

As others pointed out, the analogy would be for BP to pay itself hefty bonuses for fixing the leak in the Gulf, and ignore that they caused it.

Or if we had a nuclear plant do a melt-down, some agency rescued it, and they paid huge bonuses out of the funds to repair or contain the damaged reactor.

Or after 9/11 we started a massive Mosque building program across the USA.

If it was a crisis, then AIG should have gone into and still be in receivership, the derivative writing branch severed (and allowed to blow up, or at least claw back and indict those who wrote them), and the top 25+ people sacked with amnesty based on returning the last 3 years of bonuses.

If the Fed is now constrained, it is not because they did not do the right thing, it is that they did it so as not only to release those responsible for endangering the financial system from any responsibility, but set it up so that they profit from the disaster they created for themselves.

Next time, let the failing institution hold a board meeting with all the members, the CEO, CFO, and the top 100 managers, and send a hellfire missle to blow them all up as a terrorist organization threatening the country, then I will be happy to let the Fed do whatever it wants to fix the underlying situation.

Jimmy the Saint said...

But I also suspect that the Fed is reluctant to do more because the last time they went out on a limb and took extraordinary/unorthodox actions — bailing out AIG, establishing currency swap lines, supporting the money market funds — they were eventually savaged by politicians and the press for those actions. (And, mind you, the multiple investigations into the AIG bailout have turned up nothing legitimately untoward.)


Here is where you miss the boat. First of all, as you well know, the AIG bailout was a backdoor bailout of GS. Second, none of AIG's creditors, and certainly not GS, took a haircut. That's the problem everyone had. GS was reimbursed in full. Which is just plain nuts.

guidoromero said...

In most cases, bond holder capital was largely sufficient to absorb the entity that was blowing up so that government guarantees were unnecessary and, certainly, making creditors whole was not only unnecessary but illegal too.

But beyond that, we can only hope that the Fed's inaction is born of somebody's ability to notice empirical evidence. Since 1980 GDP has progressed from US$6Trillion to about US$14Trillion today but during the same period of time, Federal debt has progressed from US$2Trillion to about US$12Trillion today.

It is baffling that nobody should notice neither the fact that this is already a grossly overstimulated economy nor the glaring evidence of the diminishing marginal utility of debt

Anonymous said...

The AIG bailout WAS NOT a backdoor bailout of GS. Only dunces and Cassano believe that silly nonsense.

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