Surveillance Over the Federal Reserve: On the Sanders Amendment to the Dodd Senate Financial Regulation Bill
This afternoon, if I am correctly informed, President Obama is going to come out in opposition to Vermont Senator Bernie Sanders's amendment to the Senate financial regulation bill calling for the GAO to regularly audit the Federal Reserve's conduct of monetary policy.
My left-wing friends are not surprised but are, once again, disappointed. "Doesn't Obama know who his friends are?" they ask, with the answer being: "No." "Doesn't Obama recognize that Federal Reserve governance and policymaking is badly broken?" they ask, with the answer once again being: "No." Has Obama made any proposals to improve Federal Reserve governance and policymaking?" they ask, and the answer is: "No." "Of the five seats on the Federal Reserve Board of seven that he has had the opportunity to fill," they say, "Obama filled one early with Dan Tarullo, filled the chairmanship by reappointing Ben Bernanke--a dedicated public servant and excellent monetary economist and policymaker but certainly no Democrat, and has simply left the other seats empty, two of them for more than a year (although he did six days ago announce names of candidates whom he would nominate, although he has not yet nominated them). Doesn't this extraordinary lack of concern for the issue and lack of action on what is in the president's power indicate an extraordinary dropping of the baton on Federal Reserve issues? Hasn't he forfeited his authority to set out the Democratic Party's position on these issues, and shouldn't we be very grateful than somebody--in this case, Bernie Sanders--is picking up the baton and running with it?"
And when they put it that way, I cannot say "no" to anything they say.
And I have no doubt that Federal Reserve governance and policymaking is broken. Ben Bernanke ought to be in the center of opinion when the Federal Open Market Committee deliberates--not on its left wing. A large number of votes on the FOMC are held by people whose background and expertise is, at best, orthogonal to the skills needed to make monetary policy in the twenty-first century. The Federal Reserve suffers from problems of values and problems of analysis. The problem of values is that a great many of those making policy do not take the Federal Reserve's dual mandate seriously--that they are tremendously upset at the thought that inflation might rise above 2% per year in some future scenarios but utterly unconcerned with the fact that unemployment is kissing 10% and projected to decline only very slowly. The biggest example of the problem of analysis is the failure of the Federal Reserve in the mid-2000s to understand just how vulnerable our economy had become to a run on the shadow banking system and just how overleveraged and overexposed to tail risk shadow banks' portfolios had become. It's not that I am saying I should have the job: I didn't understand these things either. But I did not have regulatory oversight authority to dig into the workings of big banks to figure out what was going on.
Bernie Sanders wants to move Federal Reserve governance and policymaking in a positive direction by removing a 1978 restriction on the GAO's ability to audit the Federal Reserve. At the moment a 1978 law prohibits the GAO from looking at (i) deliberations and actions on monetary policy matters by the Federal Reserve Board, (ii) communications related to monetary policy by Federal Reserve staff and policymakers, and (iii) transactions executing decisions of the FOMC. He would remove these restrictions on what the GAO can investigate, and require the Federal Reserve to publish what banks have borrowed and are borrowing from it, and on what terms.
The Federal Reserve's opposition to the Sanders amendment appears to have three parts:
- The Federal Reserve does not want to have its elbow joggled by the Congress or the GAO.
- The Federal Reserve does not want members of congress routinely hunting through transcripts searching for quotes that they can take out of context and use for destructive purposes. Currently members of congress have to do real work to accomplish this, and the Federal Reserve wants to keep it that way.
- The Federal Reserve is worried that if the GAO begins to routinely audit monetary policy, the quality of its own internal deliberations will suffer. People will keep quiet rather than discuss things that they think might be damaging to their reputations if taken out of context. And people will keep quiet rather than discuss things that they think might be damaging to their reputations if taken in context--things that they don't want public but that are nevertheless shaping their thinking and decision-making. In any policymaking process, you want the considerations that are actually shaping people's views and actions out on the table where they can be discussed, examined, evaluated, and judged, rather than kept in the back of people's minds unchallenged because whatever they say now will show up in six months in the next GAO report. It is the executive privilege argument--only the "executive" in this case is the Federal Reserve Board and the FOMC.
If I can summarize the Federal Reserve's position, it is that detailed scrutiny of its internal processes and thoughts is something that should be left to rare after-the-fact investigations that attempt to understand crucial moments and decisions, and that having the Federal Reserve have to all the time live naked inside a glass house would have a chilling effect on the quality of its work.
Bernie Sanders's position, on the other hand, is that the Federal Reserve clearly missed some big things in the mid-2000s, and more eyes on the issues might have helped. If the GAO had been asking why Chairman Alan Greenspan was so unconcerned with issues of housing finance that were clearly distressing and perplexing Governor Ned Gramlich and if the Federal Reserve had been forced to answer more pointed questions more directly, perhaps mistakes could have been avoided.
If I thought the Federal Reserve were working reasonably well--that what we have here is a problem of analysis, a failure to take one of many potential sources of risk seriously enough--it would be easy. I find myself flashing back to the last time I saw Tim Geithner in the flesh, in... I think it was... the summer of 2005. Two now-senior members of the Obama administration and I were peppering him with questions about the stability of the U.S. financial system: What would happen if foreign central banks suddenly stopped buying dollar assets? Did JPMorganChase have control of its derivatives book? Would Lehman Brothers survive a sudden 25% fall in the value of the dollar, or had underlings written enough out-of-the-money puts and other derivatives on foreign exchange that a five-sigma move in the dollar would bankrupt it? And Geithner convinced me, at least, that he and the Federal Reserve Bank of New York were on the case: properly conducting their mission of surveillance over banks' positions in the foreign exchange derivatives market and ready with contingency plans to deal with a dollar-centered global foreign exchange crisis should one occur.
Only that was not the crisis we had...
I really wish that we had been peppering him with questions about the rating agencies and mortgage-backed CDOs and about whether firms that claimed to be following the originate-and-distribute model really were distributing. I know that I said often in 2005 and 2006 that subprime and the housing bubble were not a big threat to cause a financial crisis and a deep recession because "the banks are not holding onto these loans but are instead selling them off--it's not as though leveraged financial institutions are holding these things; a real-estate crash would probably have small macroeconomic effects just as the dot-com crash did." It would have been nice if somebody inside the Fed had back then been doing the legwork to establish that I was wrong...
If I thought the Federal Reserve were working reasonably well then the appropriate response is not an expanded regular GAO audit but instead an expanded Humphrey-Hawkins process: to throw more resources both from Congress and from the Federal Reserve into a greatly expanded "risks and contingency plans" section of the Federal Reserve's Humphrey-Hawkins documents.
But my problem is that I do not think that the Federal Reserve is working reasonably well. I do not think that the dominant views of monetary policy in the FOMC right now are informed by American values and a reality-based assessment of the state of the economy. That a good many of the people speaking and voting in the FOMC are the wrong people to do so did not matter (much) when the Federal Reserve was dominated by the incredibly charismatic (yes, I mean that) philosopher-central banker-princes of William McChesney Martin, Arthur Burns, Paul Volcker, and Alan Greenspan, but it matters now.
So I am willing to defer to President Obama's judgment that the Federal Reserve's desire for a modicum of central banker privilege is worth respecting, and that the Sanders amendment is the wrong treatment for the disease. I am willing to do so, in large part, because I think the problems are not those that detailed routine investigations of staff communications would solve: the staff of the Federal Reserve do, it seems to me, overwhelmingly have a reality-based vision of the economy, conduct thorough and appropriate analyses of risks and scenarios, and understand the Federal Reserve's dual mandate.
But I ask President Obama: What is your alternative? What is your alternate plan for improving the quality of Federal Reserve decisions--for getting policymakers who properly understand the state of the economy and who believe in the Federal Reserve's dual mandate? It's very hard to beat something--even a bad something--with nothing. And you have had... eighteen months, with only the appointment of Dan Tarullo and the reappointment of Ben Bernanke to show for it.