Tom Lindmark's  Instablog

 You may have heard of a petition that is making the rounds of economists calling on Congress and the Executive Branch to do certain things to ensure the independence of the Fed. Here is a link to the WSJ RealTime Economics Blog that has the wording of the petition and the signatories so far. Since some of you can't get past the WSJ fire wall, here is the text part of the petition:

Open Letter to Congress and the Executive Branch

Amidst the debate over systemic regulation, the independence of U.S. monetary policy is at risk. We urge Congress and the Executive Branch to reaffirm their support for and defend the independence of the Federal Reserve System as a foundation of U.S. economic stability. There are three specific risks that must be contained.

First, central bank independence has been shown to be essential for controlling inflation. Sooner or later, the Fed will have to scale back its current unprecedented monetary accommodation. When the Federal Reserve judges it time to begin tightening monetary conditions, it must be allowed to do so without interference. Second, lender of last resort decisions should not be politicized.

Finally, calls to alter the structure or personnel selection of the Federal Reserve System easily could backfire by raising inflation expectations and borrowing costs and dimming prospects for recovery. The democratic legitimacy of the Federal Reserve System is well established by its legal mandate and by the existing appointments process. Frequent communication with the public and testimony before Congress ensure Fed accountability.

If the Federal Reserve is given new responsibilities every effort must be made to avoid compromising its ability to manage monetary policy as it sees fit.

On Econbrowser, James Hamilton raises some concerns about the Fed's new balance sheet and how it may be impacting its independence:

The reason I find that loss of Fed independence to be a source of alarm is the observation that every hyperinflation in history has had two ingredients. The first is a fiscal debt for which there was no politically feasible ability to pay with tax increases or spending cuts. The second is a central bank that was drawn into the task of creating money as the only way to meet the obligations that the fiscal authority could not. Every historical hyperinflation has ended when the fiscal problems got resolved and independence of the central bank was restored.

Surely it is not far-fetched to suggest that the U.S. faces a profound political challenge in using spending cuts or tax increases to meet its current and planned fiscal obligations. Here's an observation that brought that reality home to me on a personal level: in fiscal year 2006, receipts collected by the U.S. federal government from personal income taxes totaled $1.06 trillion. Thus, to a first approximation of what an extra trillion dollars in taxes would mean for me personally, I just take the number I paid in 2006 and double it. And then I ask myself, how likely is it that Congress would actually do such a thing? With budget deficits in excess of a trillion dollars annually for the foreseeable future, it seems we are already well past the point at which the ability of the Treasury to fund the expanded liabilities through tax increases would reasonably be questioned.

My personal view is that the Fed has been ceding its independence for some fairly long period of time and that the financial crisis simply put an exclamation point on the process. If it is going to be reclaimed, it will take a new Chairman and probably a crisis similar to what Volcker faced.

 This is from Michael Pettis's China Financial Markets. It should probably be like the Pledge of Allegiance used to be in school, a required recitation before the meeting of any bank board of directors.

 Floyd Norris has an excellent post up today concerning CIT and the financial system. I'd like to talk quickly

about one of the points he makes.

Here is what he has to say:

Despite the slight opening of financial markets since the winter panic eased, this country does not have a decently functioning financial system. It is the Federal Reserve and the Treasury that decide which financial companies stay in business, which is something you expect from a centrally planned socialist economy, not from the great bastion of the free enterprise system.

Many of the better-off banks were able to repay the TARP money to the government, but they remain dependent on F.D.I.C.-guaranteed loans. CIT would be O.K., at least in the short term, if it could get such loans.

There has been a lot of hand-wringing over the failure of the Obama stimulus plan to get the economy moving, but where attention is really needed is the failure to get the financial system going. That was never going to be easy, but the worst possible decision was to allow the banks to fudge their financial statements. The Obama administration did not lift a finger to prevent Congress from demanding such a move, which the Financial Accounting Standards Board made under duress.

It is not easy to be sure how much difference that made in financial statements, although it clearly allowed some banks to pretend their losses were less than they really were — at least as measured by market values. The banks claim those market values are ridiculously low, but they will not divulge exactly what assets they own, or where they value them.

We are back to a situation where no one knows which balance sheet can be trusted. In that climate, the easiest decision is to trust no one — or at least no one without a credit line backed by Uncle Sam. Citi is too important to fail, but CIT may not be.

Remember General Growth Properties, the real estate mall owner that filed for Chapter ll earlier this year? They own some of the best retail space in the world. Their demise was not caused by an inability to meet their monthly interest obligations, it was caused by the inability of the financial system to accommodate their need to roll over debt. Debt that they could have easily serviced.

Now CIT finds itself in the same hole. It isn't so much a question of CIT's ability to service its existing debt or the new debt it needs to replace it as it is a question of its standing among the financial companies in the country. Is it or is it not a GSE is the real question.

There is only a pretense right now that the financial markets are functioning. Risk is measured by the prospect of how much government protection you may be able to muster not by the strength of your balance sheet or the certainty of your revenues. The only acceptable risks are sovereign risks and the rest will find no home.

Government guarantees have become the drug upon which the credit markets rely to maintain life. It's one of the most addictive of elixirs. Weaning the markets from it will be very difficult and the more often it is administered, the more habit forming it becomes. Like any other dependency, recovery only occurs when the drug is taken away completely. Cold turkey is a traumatic experience which sooner or later we will have to employ.