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| Accounting for the blowout / Project Syndicate Posted: 19 Jan 2022 10:45 AM PST A Project Syndicate Essay. Before it moves on to climate change, inequality, and racial issues, the Fed should have to think just a little bit about the evident failure of its existing financial regulation. Why Isn't the Fed Doing its Job? The nomination of new members to the US Federal Reserve Board offers an opportunity for Americans – and Congress – to reflect on the world's most important central bank and where it is going. The obvious question to ask first is how the Fed blew its main mandate, which is to ensure price stability. That the Fed was totally surprised by today's inflation indicates a fundamental failure. Surely, some institutional soul searching is called for. Yet, while interest-rate policies get headlines, the Fed is now most consequential as a financial regulator. Another big question, then, is whether it will use its awesome power to advance climate or social policies. For example, it could deny credit to fossil-fuel companies, demand that banks lend only to companies with certified net-zero emissions plans, or steer credit to favored alternatives. It also could decide that it will start regulating explicitly in the name of equality or racial justice, by telling banks where and to whom to lend, whom to hire and fire, and so forth. But before considering where the Fed's regulation will or should go, we first need to account for the Fed's grand failure. In 2008, the US government made a consequential decision: Financial institutions could continue to get the money they use to make risky investments largely by selling run-prone short-term debt, but a new army of regulators would judge the riskiness of the institutions' assets. The hope was that regulators would not miss any more subprime-mortgage-size elephants on banks' balance sheets. Yet in the ensuing decade of detailed regulation and regular scenario-based "stress tests," the Fed's regulatory army did not once consider, "What if there is a pandemic?" When a pandemic did arrive in early 2020, the Fed repudiated the "never again" promises of 2008, this time intervening on an even larger scale. That March, the dealer banks proved unable to intermediate the market for plain-vanilla US Treasury securities. So, the Fed propped up the market. Critics had long pointed to problems with the Fed's liquidity rules, and fixing these markets would have been simple, but obvious reforms had languished. Later, there was a run on money market funds. The Fed bailed out money market funds once again. There is nothing simpler to fix than money-market runs, but the fix never happened. The Fed also funded new municipal-bond issues and propped up corporate bond prices, essentially offering a whatever-it-takes guarantee. In 2008, the Fed and the Department of the Treasury had balked at the idea of raising the market price of all mortgages under the Troubled Assets Relief Program. Yet in 2020, the "Powell put" had established an explicit floor for corporate bond prices – and more. The predictable rejoinder to this critique will be: So what? The COVID-19 lockdowns might well have triggered a financial crisis. The flood of bailouts worked, so much so that our problem today is inflation. We do not need to worry about systemic risk, because the Fed and the Treasury will just put out any new fires with oceans of new money. The problem, of course, is the incentives these policies have created. Why bother keeping cash or balance-sheet space to buy on the dip, provide liquidity, or treat a "fire sale" as a "buying opportunity?" The Fed will just front-run you and take away the profit. If you are a company, why issue stock when you can just borrow, knowing that the government will prop up your debt or bail you out, as it did for the airlines? If you are an investor, why hesitate to buy shaky debt, knowing that its value will be guaranteed by another "whatever-it-takes" commitment from the Fed in bad times? No wonder America is awash in debt. Everyone assumes that taxpayers will take on losses in the next downturn. Student loans, government pensions, and mortgages have piled up, all waiting their turn for Uncle Sam's bailout. But each crisis requires larger and larger transfusions. Bond investors eventually will refuse to hand over more wealth for bailouts, and people will not want to hold trillions in newly printed cash. When the bailout that everyone expects fails to materialize, we will wake up in a town on fire – and the firehouse has burned down. In 2008, regulators and legislators at least had the sense to recognize moral hazard, and to worry that investors gain in good times while taxpayers cover losses in bad times. But the 2020 blowout has been greeted only with self-congratulation. The same Fed that missed the subprime-mortgage risks in 2008, the pandemic in 2020, and that now wishes to stress-test "climate risks," will surely miss the next war, pandemic, sovereign default, or other major disruptive event. Fed regulators aren't even asking the latter questions. And while they issue word salads about "interconnections," "strategic interactions," "network effects," and "credit cycles," they still have not defined what "systemic" risk even is, other than a catch-all term to grant regulators all-encompassing power. Regulators will never be able to foresee risks, artfully calibrate financial institutions' assets, or ensure that immense debts can always be paid. We need to reverse the basic premise of a financial system in which the government always guarantees mountains of debt in bad times, and we need to do it before the firehouse is put to the test. Better regulation can bridge partisan divides. The left is correct that big banks are inefficient oligopolies that serve most Americans poorly. But it has the cause wrong. An immense regulatory compliance burden is a major barrier to market entry. Calls for "more" regulation are meaningless. Regulations are either smart or dumb, effective or ineffective, full of undesired consequences or well designed. We need better regulation. We need more capital, not many more thousands of pages of rules. Capital provides a buffer against all shocks, and it does not require regulators to be clairvoyant. The Fed has scandalously blocked narrow-banking enterprises and payments providers that could help serve many Americans' financial needs. Before turning to healing the planet and righting injustice, the Fed should be held to account for how badly it is doing on the basic task of protecting the financial system.
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| Posted: 18 Jan 2022 03:35 PM PST I salute President Biden's nominations for the Federal Reserve Board, especially Sarah Bloom Raskin and Lisa Cook. (Philip Jefferson seems straightforward and uncontroversial, but other than reading a CV I haven't looked that hard.) We can now have an honest conversation about where the Fed is going, and whether and how the Fed should use its tools, primarily regulation, to advance the Administration's agenda on climate, race, and inequality. The Wall Street Journal nicely assembled crucial quotes on Ms. Raskin and climate. In 2020,
Writing in the New York Times in May 2020,
Writing for Ceres,
My emphasis. The report also
This is wonderful. For the last year that I have been following the issue, it has all been clouded in what I regard as deceitful misinformation -- Oh, we're not trying to regulate climate policy. That's beyond our mandate. We just look around at risks to the financial system and lo and behold we find that climate poses an important risk to the financial system. So we're just doing our job as dispassionate financial regulators. The idea of climate risk to the financial system is, in my view (and my reading of the scientific literature) so farcical that I called this out as a subterfuge. But there the argument lay. No more. Thank you Ms. Raskin for stating the truth so clearly. Now we're ready to put that nonsense smokescreen aside and have an honest debate. Should the Fed get involved in allocating capital in order to pursue climate policies? Especially to go beyond what Congress, Administration, and EPA are willing to do, for fear of wrathful voters? Ms. Raskin is superbly qualified and experienced. If you don't like these policy preferences, that makes her more dangerous as she has the knowledge and skill to implement them. That's great too -- the discussion can't get derailed over qualifications. ******** A few journalists approached me to ask about Professor Cook's qualifications. Since they had an obvious agenda, I did not comment. But it is a line of argument you will hear. My answer is simple: It depends what the job is. Just spend some time on her website. Read her CV. Cook is an academic, so her main qualification is her writing, not business or other experience which some other Fed board members bring. Indeed, in her extensive writing for academic journals and think tank essays listed under "publications," you will find essentially nothing related to monetary policy, monetary effects on employment, interest rates, inflation, financial regulation or other traditional Fed topics. (Maybe her most cited paper "Trade Credit and Bank Finance: Financing Small Firms in Russia," Journal of Business Venturing, 1999 counts, but on the conventional basis it's a slim basis to sit at the Fed.)0 But, to keep a blog post short, just read a selected few of the most recent publications:
It goes on like this. Her bio lists a bewildering number of institutional affiliations:
(My only complaint: Her bio lists her has having been "a National Fellow at Stanford University." No, she was a National Fellow at the Hoover Institution, at Stanford University. Which signed the checks. Her CV lists it correctly. I'm only sensitive because people accuse Hoover of being right-wing, and here is contrary proof.) She is currently a member of American Economic Association Executive Committee (She does more than she even can keep up with on her CV and bio!), and serves on the Committee on the Status of Minority Groups in the Economics Profession of the American Economic Association, which is conducting an expansive "diversity" initiative. So, I answer the question, Lisa Cook is superbly qualified, by written word, experience, and connections -- if the job is to bring the Administration and progressive supporters' racial policies to the Fed. That might mean requiring DEI or ESG practices at banks, or to companies that banks lend to, directing credit to some areas or by race, and strengthening the DEI initiatives and race based hiring and promotion practices within the Fed. Should the Fed be doing that? Again, thanks Mr. President, we can now have a straightforward discussion. |
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