The Fed's Precarious Position: Independence vs Power at War in the Fed's Continued Evolution

The story of the Fed's curious evolution at gunpoint reminds me of the story in yesterday's UK Guardian on How Neanderthals met a grisly fate: devoured by humans - I hope the correlation is not lost on you, dear reader.

The Federal Reserve surely understands that it is now in completely unknown territory, attempting to stem financial crisis while at the same time interfering (or dabbling, depending on how you look at it) in the fine art of regulatory reform based on recent experience. Both formulating expansion of duties and trying to control the direction of the FAILboat through these choppy waters is certainly a challenge, and one that will likely cause the Fed to diverge from its declared goal of independence from political influence.

Now, most of us realize that this line is exactly that, a line - the obscured goal hidden behind layers of typical central banker code.

Via CompliancEx, an enlightening look at the Fed's curious predicament in the face of full-on financial meltdown:

This time around, the Fed could gain some important powers as the new financial-stability regulator, such as the authority to rein in financial institutions so big that they can put the entire system at risk. But it could lose some other powers, such as the authority to regulate consumer-finance activity or to lend unchecked in emergencies. And Congress could chip away at the Fed's hard-fought independence, particularly the law that allows commercial bankers to pick the boards that oversee regional Fed banks.

It is too early to know whether the Fed will emerge from this reshuffling a weakened, less effective institution or one with more power and prestige. The stakes are huge. An ineffective central bank can wreck an economy by fueling inflation or creating financial instability. Much depends on how the economy responds to its medicine. If a recovery takes hold, the Fed will have lots of bargaining power.

"The Fed is going to change," says Frederic Mishkin, a Columbia University professor who served as Fed governor until last August. "If things go right in terms of politics it won't be a radical change."

One of Mr. Bernanke's key allies in Congress, Rep. Barney Frank (D., Mass.), says he doesn't want to take up many of these issues until next year. "You are in the midst of a crisis," says the chairman of the House Financial Services Committee. "I would not want to be seen as impinging on the Fed's ability to deal with the crisis."

Barney Frank would do us all well to keep his mouth shut, IMHO, but we all know that isn't going to happen any time soon.

While the article goes on to explain the particulars of Fed independence (in case you need a refresher, or perhaps for the sake of the Fed itself who seems confused as to its approved and acceptable duties these days), it narrows its focus to the all-important regional Fed banks who stand to lose the most in the battle over independence vs. power. One will have to be sacrificed for the other and it is likely that the Fed's Board of Governors will be changed little by any potential outcome.

The governance of the regional banks is coming under increased scrutiny. Earlier this month, Stephen Friedman, chairman of the Federal Reserve Bank of New York, stepped down abruptly after questions arose about his dual roles as a Fed official and a director of Goldman Sachs Group, which has benefited from government rescues. Congress also passed a resolution calling for closer scrutiny of the regional banks.

"If the Fed's independence is attacked, this is where it is going to happen," Mr. Mishkin says.

Mr. Frank says he is troubled that the regional Fed presidents tend to be more hawkish on interest rates than the members of the Fed board in Washington, who are picked by the president and confirmed by the Senate. Some lawmakers want to consider subjecting the regional Fed presidents to the Senate-confirmation process.

I do not believe that Mr Friedman's situation is representative of any regional Fed bank "issue" - the New York Fed is its own beast and in many ways can be considered more subversive than the Board in that it is populated with Goldman rats and carries a seedy reputation as the most questionably-connected of the 12 regional banks. Have you ever heard of Dallas Fed being involved in a conflict of interest scandal that lead to some $1.5 million in pure profit by conveniently rewriting Fed rules? I didn't think so.

It is not the regional Fed banks themselves that need to be scrutinized but the Federal Reserve System as a whole and most importantly the NY Fed. Let's start picking at them first and work our way down before any of these asshats, be it FDIC's Bair or Barney Frank or Ben Bernanke himself, start suggesting the Fed would be the institution best equipped to serve as ultimate bank and non-bank regulator.

No agency which claims such independence from the process of democracy should be allowed to take such dramatic steps towards control without having to lay a few of its cards on the table first. And I'm sure NY Fed has more than one bluff to be called.

Jr Deputy Accountant

Some say he’s half man half fish, others say he’s more of a seventy/thirty split. Either way he’s a fishy bastard.