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:
- “Arrange large-scale reverse repurchase agreements.” The problem is that repo agreements only temporarily withdraw money from the system.
- 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.
- 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.
- “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.