Saturday, July 06, 2013

The role of the Fed

At a recent Occupy Alt Bank (Occupy's Alternative Banking think tank) there was this exchange. 

'Banks find ways to skirt any regulation whatsoever," said one member.

"Jailing the CEOs will curtail their risk behavior," replied another.

I wondered: "They can't be jailed for skirting the law unless they break it. But there is a way to curtail risk outside regulation and law entirely -- the Fed." 

Both Barry Eichengreen and George Cooper, independently and from different political perspectives, came to the same conclusion, and even Greenspan in effect admited this: the Fed encourages risk through stabilizing the economy, broadcasting its intentions to keep the money flowing. If the Fed (I know, I know, it's counterintuitive and sounds just awful) were less transparent, played its cards closer to its chest, and threatened to tighten money suddenly and by surprise, letting a few excessively risky institutions fall off the cliff, the banks would learn a piece of Old Testament Fear of the Fed. The threat itself might suffice after one example. It'd have an effect similar to jailing CEO's, but without the need for a law, a court, prosecution, evidence or lawyers. Of course, you wouldn't want the Fed to try this now in the midst of a recession, but during flush times. 

Stiglitz has complained about this as well -- the Fed used interest rates to prevent business cycle downturns, encouraging risk.

The Fed has no oversight, so you can't even effectively lobby them. But it might help for the public to know this stuff and for Occupy to stake out a position.

Alt Bank is producing a book on breaking up the banks. I'm disappointed that they're not including a chapter on the Fed. Including a brief history of its failure in the Great Depression, Volcker's success stemming inflation, and Greenspan's questionable use of rates (in light of the flagging US export economy and the Fed's encouragement to shift to a financial economy -- another issue that should be addressed) would lead to a couple of recommendations: less Fed transparency and yet more oversight and accountability. Difficult to juggle those two...

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