The Fatuous Fed

Chris Whalen

Chris Whalen is one of the better financial analysts around Wall Street. His specialty is banking and he was one that warned early and often of the coming collapse of the financial system. Mr. Whalen has written a detailed analysis of the Federal Reserve entitled I am Superman: The Federal Reserve Board and the Neverending Crisis.

The abstract of the article follows:

This article asserts that, in dealing with the 2007-2009 financial crisis, the Federal Reserve Bank (Fed) has placed its role as monetary agency and de facto steward of the market for U.S. Treasury debt ahead of its statutory responsibility for ensuring the soundness of the private banks. This is not to say that the Fed supplies whatever credit the government wants — at least not yet — but in terms of both the provision of credit to the private financial system and the price of this credit, the growing fiscal imbalances of the U.S. government seem to be playing an increasing role in Fed policy decisions. This paper explores some of the issues involved in recent Fed policy decisions and draws some preliminary conclusions as to the conflicts between the Fed’s role as central bank and also as prudential supervisor.

Here are a few quotes from the article. Any emphasis has been added by me.

The Fed knows that it is only one fiscal crisis away from the same situation that prevails today in the UK, France and Germany, where decapitalized banking systems are collapsing back into the arms of equally enfeebled, heavily indebted states.

During the 2007-2009 financial markets crisis, the Fed seemingly left behind the mandate to conduct monetary policy in such as way as to achieve price stability and full employment. Specifically, the decisions taken during the financial crisis seem to be an effort to placate political constituencies by bailing out private sector banks and, earlier, by not exercising appropriate prudential supervision of Fed members banks and bank holding companies (BHCs).

…the Fed has shown a willingness to bend the rules or even launch into new, speculative areas of public policy, all in the name of appeasing the short-term political agenda of the Congress and the largest U.S. financial institutions.

The focus by the Fed on credit expansion, as opposed to price stability and interest rates, and a lack of attention to choices being made with respect to market structure and the regulation of Fed member banks served to make the crisis of 2007-2009 far more difficult than ought to have been the case.

Fed officials fall into the trap of believing that direct intervention in the financial markets is actually helpful, instead of an act of interference in the political process of American democracy.

… there appears to be something about central banks and the study of macroeconomic policy in general that seems to make the inhabitants of the given agency concerned believe in the possibility of an all-encompassing “God’s eye view” of markets and agents.

… there is also an unwillingness among the leadership of the central bank to admit when they are wrong, especially when it comes to the development or recognition of systemic risks in the financial system…

…the Fed is so busy keeping the U.S. economy growing at some minimal, politically acceptable level of growth and at the same time working to prevent the over-indebted U.S. government from sliding into monetary collapse that managing the nation’s banks has at best taken a back seat. The real problem in the U.S. over the past decade was that Bernanke and the other members of the Fed Board were so committed to targeting a minimum level of private credit expansion that they ignored other indications that something was seriously amiss in the financial system.

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