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October 2011, Week 3

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Mon, 17 Oct 2011 22:09:06 -0400
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Democracy Versus Bankers at the Fed 

Monday 17 October 2011 by: 

Dean Baker, Truthout | News Analysis

http://www.truth-out.org/democracy-versus-bankers-fed/1318857810

The Federal Reserve Board has provided the basis for
thousands of conspiracy theories in its near 100-year
existence. These conspiracies have some basis in
reality as can be seen by the Fed's recent moves on
monetary policy. In the last two meetings of the Fed's
Open Market Committee (FOMC), the Fed's key
decision-making body, the members appointed through the
political process unanimously supported stronger
measures to spur growth and create jobs. By contrast,
three of the five voting members appointed by the
banking industry opposed further action.

This extraordinary split has not received the attention
it deserves. It suggests that the financial industry is
using its power at the Fed to try to block the course
preferred by the appointees of democratically elected
officials of both parties.

The Fed is an enormously important if poorly understood
institution. Its control of monetary policy (primarily
short-term interest rates), gives it the ability to
speed up or slow growth. It also has enormous
regulatory power. Alan Greenspan could have used this
authority to put a check on the junk loans that fueled
the housing bubble in the years 2002-2006.

If the Fed wants to ensure that the economy does not
grow too rapidly it can slow growth by pushing up
interest rates. This was the cause of all the post-war
recessions prior to the last two as the Fed raised
interest rates in order to reduce growth and employment
and, thereby, slow inflation.

The Fed can also boost growth by lowering interest
rates. To counteract the current recession, the Fed
lowered its short-term rate to zero. Since this is as
low as interest rates can go - the Fed can't have
negative interest rates - the Fed has tried to reduce
long-term interest rates by measures such as the
quantitative easing policies adopted in 2009 and 2010,
and more recently the purchase of long-term bonds
through "Operation Twist."

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to Truthout this week. Click here to support news free
of corporate influence.

This is where the issues of control come in. The FOMC
has 19 members. Seven of these members are governors of
the Federal Reserve Board. These governors are
appointed by the president and approved by Congress.
They serve a 14-year term. The extraordinary length is
intended to ensure their independence. They can use
their best judgment without worrying that the current
president or Congress will take away their job.

However, the other 12 members of the FOMC are not
appointed by democratically elected officials. They are
the 12 regional bank presidents. While the process of
selecting the regional bank presidents is somewhat
complicated, it is largely controlled by the banks
within a region. This means that 12 of the 19 members
of the FOMC are selected by the banks. At any point in
time, only five of the 12 bank presidents have a vote.
This gives the governors a 7-5 majority among the
voting members, even though they are outnumbered 12-7
on the FOMC as a whole.

Most of the time, decisions by the FOMC are unanimous.
The FOMC typically discusses the current economic
situation for two to three hours and considers possible
actions. By the time a vote is called, everyone has
expressed their opinion so the outcome is already
known. In the interest of showing support for the Fed,
most members agree to support the majority decision to
make it unanimous. Occasionally, one member will make a
point of dissenting to show that he or she felt
strongly about the issue being considered.

The last two meetings of the FOMC were extraordinary in
that they featured not one, but three dissents.
Furthermore, it was striking that all three dissents
came from the bank presidents who were appointed by the
banking industry.

The immediate issue at hand is whether the Fed should
be trying to do more to boost growth and create jobs.
The five governors (there are two vacancies) appointed
through the democratic process all felt that it was
important to do more to generate jobs. This was a
bipartisan sentiment. Three of these members were
appointed by President Obama, one was appointed by
President Bush and one (Chairman Bernanke) was
appointed by both.

However of the five people appointed by the banking
industry, three voted against stronger measures. The
likely explanation is that bankers don't care much
about unemployment. After all, they have jobs, as do
most of their friends. On the other hand, inflation is
really bad news for banks. It directly reduces the
value of their assets.

This means that when the Fed debates a policy that
risks somewhat higher inflation in order to reduce
unemployment, the bankers' answer is to screw the
unemployed. The outrageous part of this story is that
the bankers don't have to push their agenda as an
outside interest group; they actually have seats
directly given to them on the FOMC.

This would be like letting Pfizer or Merck pick two of
the five commissioners for the Food and Drug
Administration, or letting Comcast and Disney pick
members of the Federal Communications Commission. All
regulatory agencies are susceptible to inappropriate
influence by the affected industry groups, but in the
case of the Fed, the country's most important
regulatory body, the industry group is already on the
inside.

An overhaul of the Fed is long overdue. It should be
turned into a body that directly answers to Congress
just like every other regulatory agency. And the
bankers must go. This would be a great way to mark the
Fed's 100th anniversary in 2013. We can make it an
institution that is consistent with democracy.

___________________________________________

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