It’s a great strength of the Federal Reserve that it gets to operate above the dysfunctional and grubby political give-and-take that goes on everywhere else in Washington. And its insiders know that.
“We are the grown-ups in town,” former Fed Gov. Kevin Warsh reminded his colleagues in a summer 2010 monetary policy meeting. “We are the last folks, rightly or wrongly, fairly or unfairly, in a global economy that demands institutional credibility, and we should be thinking long about the decisions that we make.”
That thinking worked great for the Fed up until the American people started to wonder if the grown-ups were looking out for them and not just big financial companies. And just who put them in charge?
That doubt worries political scientist Larry Jacobs, the director of the Center for the Study of Politics and Governance at the University of Minnesota’s Humphrey School and the co-author of a new book called “Fed Power: How Finance Wins.”
He doesn’t suggest getting rid of our Federal Reserve but making it a stronger central bank — what we will need to get through the next financial crisis. Our Federal Reserve came out of the last one badly damaged, he said.
It was political damage and mostly self-inflicted.
While he has plenty to say about what the Fed did around the 2008 financial crisis, what led Jacobs to his conclusions is how it did it — largely on its own and almost completely out of sight of the public.
When Jacobs started looking into the Federal Reserve in 2010, he said, he was surprised to learn just how much had been committed by the Fed to banks and other financial institutions, dwarfing the $440 billion bailout that had been sharply debated and then approved by Congress.
“I kept wondering, ‘How are they doing this?’” he said, of the Fed policymakers. “It just seemed to me to be very peculiar and not what I know of American democracy.”
His criticism of finance will have readers with a finance background like mine sighing out loud, yet Jacobs also readily volunteered that the Fed is run by some of the brightest people in our country. And he will agree with me that, in a time of crisis, at least our Fed acted decisively.
The problem, he said, is the Fed just kept going. It created what he called an “alphabetic kaleidoscope” of financing programs to support banks as well as things like money market funds and commercial paper issuers.
The Fed kept also alive the insurance company American International Group, Inc., which had turned itself into a big guarantor of what turned out to be crappy mortgage-related securities.
To prop up AIG in September 2008 and to allow it to make good on the losses other investors would have had to take if their AIG “insurance” turned out to be worthless, the Fed and Treasury Department led a bailout with taxpayer money that ultimately reached a commitment of more than $180 billion. (Both the Fed and Treasury made profits when AIG completed repayments in 2012.)
The Fed called its AIG projects Maiden Lane, named for the street that runs behind the back of the Federal Reserve Bank of New York.
Years later, at a trial over whether the Fed essentially stole AIG from its shareholders, the general counsel of the New York Fed was forced to deny that naming the projects Maiden Lane was some sort of Fed insider joke for what everybody understood was really just a back door taxpayer bailout of the Wall Street crowd.
The Maiden Lane transactions were typical of the problem, Jacobs said.
Here was an insurance company that wasn’t even part of the Fed’s regular bailiwick, one that the Fed both kept afloat and owned for a time.
By 2009, Jacobs asserts, the Fed wasn’t even pretending to do anything other than act on its own to boost the financial sector. In other Western democracies, with financial problems of their own, the central banks behaved far differently.
Among other things, the Bank of England had been directed by the British Parliament to make sure that any banks that received crisis-era government support also helped small businesses and homeowners, including those struggling to make their mortgage payments.
As Jacobs pointed out, the Bank of England’s governor knew that his bank either helped homeowners or he would get his head handed to him by angry members of Parliament.
Across the Atlantic, Fed officials let American homeowners mostly fend for themselves.
They might’ve been right on the economic merits but they were dead wrong on the political merits, having forgotten that one reason elected officials spread around government benefits is that it increases public support for the programs.
By late 2010, according to a Bloomberg poll, more than half of Americans wanted the Fed either brought under control or simply abolished. Another poll, one Jacobs and co-author Desmond King highlighted in their book, ranked the Fed last for job performance among nine big federal bureaucracies, well behind even the Internal Revenue Service.
“For people who lost their trust in government,” Jacobs said, “it’s because of things like what the Fed did.”
Perhaps. Elected officials also contributed to the erosion of trust in government through their actions, and sometimes their inactions. The Fed didn’t tilt the playing field for the financial industry because of an affinity for finance.
Jacobs is no fan of the populist critiques of the Fed, exemplified by former congressman Ron Paul’s book called “End the Fed.” There’s a middle ground between no central bank and the Federal Reserve we have, he said, a central bank that’s more transparent and accountable.
Perhaps the bank should have a narrower role, too, more in line with the practice in Canada, with its central bank working apart from a financial regulator.
These were among the ideas Jacobs offered in a conversation in a St. Paul coffee shop on the same afternoon that new Minneapolis Fed President Neel Kashkari presided over its first symposium on the problem of banks that are too big to fail.
There’s at least one thing on which Jacobs and Kashkari would agree: what we’ve done since 2008 to reform the financial system hasn’t been enough.
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