With No Exit Strategy, Bernanke's Fed Turns to Lobbying

The Federal Reserve is feeling somewhat vulnerable lately, and has taken some unprecedented steps to convince the public and foreign investors that the central bank is not on the path of desecrating the US dollar. Treasury Secretary and former New York Fed president Timothy Geithner, has been traveling the world trying to salvage confidence in the dollar amongst increasing fears of runaway inflation.

Matters have become so serious the Fed felt they need additional firepower. The Fed is independent, but it still reports to Congress. American International Group (AIG), Fannie Mae (FNM) and Freddie Mac (FRE) are forbidden from lobbying the government, but the Fed is not. Yesterday Linda Robertson, who headed Enron’s lobbying office from 2000 until the energy company’s collapse from an accounting scandal in 2002, began her job as the Fed’s first lobbyist.

Apparently part of the new lobbying strategy was for Bernanke to pre-empt his semi-annual testimony before the House Financial Services Committee this morning by taking the unprecedented step of writing an op-ed piece in today’s Wall Street Journal on “The Fed’s Exit Strategy.”

Bernanke’s emphasis that “economic conditions are not likely to warrant tighter monetary policy for an extended period” might reassure bond buyers, but a closer examination of his four point exit strategy leads to inflation.

Here’s how Bernanke intends to keep the fed funds rate at nearly zero while attempting to reduce reserves and drain excess market liquidity, and why it won’t work:

1. “Arrange large-scale reverse repurchase agreements.” The problem is that repo agreements only temporarily withdraw money from the system.
2. The Fed has to stop monetizing the debt, not “take care to ensure that we can achieve our policy objectives without reliance on the Treasury.” The sale of massive amounts of treasuries alone could mop up substantial excess liquidity.
3. Bernanke wants to “offer term deposits to banks,” similar to bank CDs to customers. In order to get banks to participate, the Fed would have to offer banks a high enough interest rate equivalent to the current commercial paper rate plus a high enough spread to make the transaction profitable.
4. “Selling a portion of the Fed’s holdings of long-term securities into the open market” would be the fastest way for the Fed to ensure its demise. How does the Fed think the public would react to the central bank incurring huge losses on securities purchased when interest rates were extraordinarily low? Imagine Bernanke going back on 60 Minutes to say that the mortgages the Fed purchased with a 4.5% interest rate were sold when prevailing mortgages jumped to 6%, at least a 30% loss in value to taxpayers. The more practical approach would be just to let the Fed’s securities mature without renewing them, while the Treasury absorbs excess liquidity by financing the massive deficit.

As today’s Wall Street Journal outlines in “Bernanke Heads to Capitol Battling Calls to Tame Fed”, the Fed is preoccupied with keeping a grip on its power while Congress is warming to the idea of going beyond the GAO’s audit of the Fed over its role in AIG to considering legislation that would audit the Fed in its entirety.

Bernanke has admitted in past Congressional testimony that the Fed doesn’t usually obtain prices before hiring financial advisors. After auditing the Fed’s role in AIG, the GAO could investigate the millions paid to BlackRock (BLK) to manage various Fed programs, including $43 million managing the Fed’s “Maiden Lane” funds for one year that holds illiquid assets from Bear Stearns and AIG. (If the assets are intended to be held for a long time, what services is BlackRock actually providing?) And let’s not forget PIMCO ($3 million per quarter) and all the lawyers (up to $1,055 an hour) and Ernst & Young providing $60 million (at $775 an hour) in accounting advice relating to AIG. And Morgan Stanley (MS) got $4 million in advisory fees and has been collecting $2.5 million each quarter since October for being primary financial advisor for any divestitures or public offerings of AIG units.

Naturally the Fed does not want any unpleasant results from a GAO audit splashed across news headlines. Even if Congress fails to pass Rep. Paul’s legislation to audit the Fed, the Fed won’t elicit any public support by continuing its campaign against consumer protection. The time has come not to abolish the Federal Reserve entirely, but to restructure it by separating consumer protection from the Fed’s role in “promoting a sound banking system.” While both objectives appear to coincide, no Federal Reserve Chairman has actually acted in a way to promote the two together. To quote a phrase often used by President Obama,* “it’s never the right time” for the Fed to raise interest rates or fight inflation. This is why the Fed’s dual mandate should be simplified to only maintaining price stability.

*The President has said this to those who oppose reforming the healthcare system now.

Disclosures: None.

Comments

[Jordan Lindsey:]

Out of all the coverage of today's Fed circus this is the best piece I have seen - there is no exit strategy and the printing of all this money will cause massive inflation.

Jul 21 05:08 PM

[dybydx:]

the price stability has been the primary role for the central bank of canada.

they aim to hold inflation between 1% and 3%. and over the past 20 yrs, they've been averaging like 2.1%. no one criticized their role in any economic booms or busts. a consistent 2% inflation is fair and reasonable for most ppl who had to rely on the currency.

they dont do stupid stuff like "trying to maximize employment" or otherwise manhandle the economy. its entirely up to the executive branch to determine whether or not a bailout is warranted.

Jul 21 05:11 PM

[whidbey:]

Nice. The truth is always interesting, but you can not take Ben B at his face value best. He is the handmaid of hell when it comes to fiscal discipline. At Princeton he was not known as a mad man on what caused the Great Depression; no, he knew that government policy was one major cause of the length of the Depression and its failure to recognize what was happening. Why is he blind today?

He knows the history, but he has drawn the wrong conclusions: More liquidity, in any amount, will not cure bad policy. He wants to support the Administration and is reluctant to say that the size of the public debt is the 800 pound gorilla in the room. He is reluctant to wind down his program "just yet". His faith in government is touching even for a socialist.

Jul 21 05:36 PM

[MktMaven:]

Looks like they got that one wrong.

On January 17, 2008, the Chairman of the Federal Reserve Board, Mr. Bernanke, testified that "A recession is probably not on the horizon, but quick passage of an economic-stimulus package plus aggressive action by the Federal Reserve are the appropriate prescription for the ailing economy.."

What we got right.

We note that on June 18, 1998, in a letter to Betsy White, Senior Vice President at the NY Fed, we said:

"Finally, it is our continuing belief that the Federal Reserve Board should be designated a 'Superregulator,' with broad responsibility for overseeing the activities of banks, thrifts, pension funds, insurance companies, mutual fund companies, brokerage firms and investment banks. We note our belief that financial institution convergence, driven by recent advancements in financial and computer technology, requires the creation of such a 'Super-regulator.' "

We, and others, no longer believe the Federal Reserve independent or objective enough to serve as "Superregulator" or as "Systemic Regulator." They are, thus, unqualified for the role, which should be filled by an entirely new entity.

See:twisri.blogspot.com/20...

Jul 21 06:11 PM

[Jason Rines...:]

The CB model itself will evolve or die in this coming era. Global ineptitude and fiscal collapses lead to world wars. Unfortunately, we are in the nuclear age. I am hoping for the best but preparing for the worst. And when it is all over, there are going to be many people around the globe, not just the USA that will demand to understand what happened. The American public will in a few short years be deciding a path of debt default creating serious geopolitical blowback or extreme austerity servicing the debt. Which one do you think they will choose? History does rythme.

Jul 21 06:21 PM

[Celcius:]

"This is why the Fed’s dual mandate should be simplified to only maintaining price stability."

I agree with this 100%. I think the FED should only be focused on keeping inflation below 0.5% to protect the value of the currency. The FED should not be involved in any of the bailouts. Corporate America should be exchanging debt for equity with their creditors. The same goes for all of the home owners in foreclosure.

Jul 21 07:04 PM

[Moon Kil Woong:]

If the Fed's mandate is only to maintain price stability that would be asking for it to cut its own throat. The simple fact is the dollar was more stable the hundred or so years without the fed than with the Fed who has depreciated it some 90 some odd percent in less than a decade.

Likewise, the US should bar the fed from lobbying since its purpose is purely to act on the behalf of the American public. But they argue thay are a normal private company. Normal is not the word for a private company backed by the US government with regulatory authority which a holds a monopoly on US bond sales. Furthermore, it is granted laws barring people from knowing who owns its shares, how it spends its money, and laws exempting it from public audits, reserve requirements, and every other financial rules known to man.

Jul 22 12:03 AM

[dcb:]

wholesale price inflation was 1.8% just last month!!!
we already are in stagflation. don't compare YOY. just look at the last five months. no real increasing economic activity but commodity prices have gone up huge.


On Jul 21 05:11 PM dybydx wrote:

> the price stability has been the primary role for the central bank
> of canada.
>
> they aim to hold inflation between 1% and 3%. and over the past 20
> yrs, they've been averaging like 2.1%. no one criticized their role
> in any economic booms or busts. a consistent 2% inflation is fair
> and reasonable for most ppl who had to rely on the currency.
>
> they dont do stupid stuff like "trying to maximize employment" or
> otherwise manhandle the economy. its entirely up to the executive
> branch to determine whether or not a bailout is warranted.

Jul 22 08:45 AM

[dcb:]

It's amazing how many people on this site make comments without understanding how the fed works. they need to read more of your posts!!!


On Jul 22 12:03 AM Moon Kil Woong wrote:

> If the Fed's mandate is only to maintain price stability that would
> be asking for it to cut its own throat. The simple fact is the dollar
> was more stable the hundred or so years without the fed than with
> the Fed who has depreciated it some 90 some odd percent in less than
> a decade.
>
> Likewise, the US should bar the fed from lobbying since its purpose
> is purely to act on the behalf of the American public. But they argue
> thay are a normal private company. Normal is not the word for a private
> company backed by the US government with regulatory authority which
> a holds a monopoly on US bond sales. Furthermore, it is granted laws
> barring people from knowing who owns its shares, how it spends its
> money, and laws exempting it from public audits, reserve requirements,
> and every other financial rules known to man.

Jul 22 08:46 AM

[Old Trader:]

If I'm not mistaken, the Fed is the only Central Bank charged with a dual mandate. I know that the ECB, and as dybydx pointed out upstream, the BC only have the single mandate of controlling inflation. I've commented in the past that controlling inflation, as well as promoting full employment are usually conflicting goals.

Jul 22 06:36 PM