New Powers for The Federal Reserve?

The Federal Reserve System is arguably one of the most powerful (and least understood) institutions in America. Treasury Secretary Paulson's recent suggestions that "The Fed" should be granted even more power is a dangerous step.

And what's even more scary is that so many editorial writers are saying that Paulson's plan does not go far enough...so the 'debate' so far has centered on whether we give the Fed "New Power," or "Lots of New Power."

I would suggest we give it NO new powers at all, and reign in some of the power it currently wields over our lives.

By way of background: There are many tools available to an administration to jump-start or safeguard an economy. Over the years, the federal government has tried direct government spending (FDR's Civilian Conservation Corps), borrowing (every adminstration since then), giving tax rebates and cuts to consumers, deregulating business, cutting business taxes, increasing direct aid to low-income people (Bush's extension of unemployment benefits, Social Security) and building transportation infrastructure. Some presidents have attmpted policies that were dismal failures (Nixon's gas rationing in the 1970s). And of course, it is certainly arguable that Government should *not* attempt to regulate the economy at all, but should get out of the way and stop messing it up natural markets.

What all of the above approaches have in common is that they are *highly* political. They require the chaos of Congressional, Presidential, and Bureaucratic action to happen. They involve log-rolling, and compromise, and committees and all sorts of political machinations. And if you're looking for results, that's not a very effective way to run an economy.

The Federal Reserve System was designed to function quite differently.

The philosophy behind the Fed is to masage the economy through a professional banking system. The Feds, rather than responding to voters, have historically responded to numbers, and made objective decisions. This is the body that sets the Discount Rate (the interest rate at which they lend money to member banks, thus influencing general interest rates). They determine the ratio of deposits that banks must keep on hand in case of a 'run' on the bank. And in New York, the Fed buys and sells government bonds in order to inject cash into the economy or withdraw it to slow down easy credit. By all accounts, The Fed is a conservative, staid, professional group of bankers that responds to bottom lines, not the whims of voters who want goodies for their district or the passion of politicians seeking reelection.

In fact, the Fed is very, very insulated from politics. Their 7 member Board of Governors is appointed by the President with the consent of the Senate, but they each serve 14 year terms. One is up for reappointment every 2 years, which effectvely means that even a two-term president can not realistically change the makeup of the majority of Governors. Even if he could, it wouldnt matter that much, because the Regulatory functions of the Fed reside in something called the "Open Market Committeee," which consists of the 7 Governors plus 5 regional, private Fed Bank presidents (there are 12 District Fed banks. Each is a private bank, with its own Board of Directors). By design, there is NO Federal Reserve Bank in Washington, DC. All in all, it is a very decentralized system, independent from most government oversight, which operates within the banking community. Unless there is a crisis, they only meet once every 6 weeks (which they did during the Great Depression, and right after 9/11)

Under Ben Bernanke, the Fed has taken some 'wild' steps. In one case, it called two meetings only 3 days apart from each other. It has dropped the discount rate precipitously. It has stepped in to private markets to arrrange a takeover of Bear Stearns by Citicorp at a price of $2/share, destroying shareholders values (and their pensions). Fortunately, that deal that is unravelling now that Morgan Stanley has offered $10 a share. Bear Stearns is a private investment house, not a bank, and the Fed had no direct authority in the matter. .

And now, Secretary Paulson has made some 'minor' suggestions to give the Fed more such authority. His proposal would give sweeping new authority to Fed to collect data and regulate private investment houses in prder to 'stabilize markets.'

But the Fed was designed to stabilize the value of *currency* by regualting member banks. It was never meant to make decisions about business practices of non-banks, or regulate private stock transactions or financing instruments.

And that's a big, big change, and a problem for a country that calls itself a democracy.

The Fed has always walked a fine line: It's greatest strength is that it is non-political, so it can be an effective and efficient institution in protecting the economy. But its greatest weakness is that it is undemocratic, and unresponsive to the voters. It exists on its own, high above the fray. Therefore, it was given very limited authority. Paulson's plans destroy that balance.

First, it takes an institution which is the nations *only* non-political approach to the economy and drops it squarely in the middle of the political arena by giving it regulatory authority over private businesses outside of its own banking system. The political pressure on the Fed to 'save' certain companies 'assets' at the expense of others will be enormous.

Second, it gives increased regulatory authority over private transactions to an institution that is essentially unanswerable to the political process. In other words, we are creating a new branch of government, with power and authority, that is not answerable to voters, or to congress, or to any democratic process whatsoever; the Fed would become Power without any check or balance, Authority without any accountability to the citizens.

If Investment houses need to be regulated, an agency (The Securities and Exchange Commisson) is already in place. If Predatory lenders need to be more tightly regulated, all 50 state legslatures have the authority to do that, and Fraud statutes exist that can be used or strengthened through the legislative process. If poor business decisions cause a business to go under, taxpayers should not be forced to prop it up (Why is it that failing businesses always want taxpayer money to help them when they fail, but they never feel that their profit should be distributed to taxpayers when theymake a profit? Hmmm........)

Paulson's plan is not a 'small step.' This is the continuing eviscerating of the Republic's Constitution.



But then, we should have come to expect that from this administration.