The Fed in Hot Water

The Fed has finally came clean. It now admits it bailed out Bear Stearns – taking on tens of billions of dollars of the bank’s bad loans – in order to smooth Bear Stearns’ takeover by JPMorgan Chase. The secret Fed bailout came months before Congress authorized the government to spend up to $700 billion of taxpayer dollars bailing out the banks, even months before Lehman Brothers collapsed. The Fed also took on billions of dollars worth of AIG securities, also before the official government-sanctioned bailout. 

Volcker and Bernanke: So Close and Yet So Far

In case you were wondering, Paul Volcker is still pressing hard for the Senate (and Congress, at the end of the day) to adopt some version of both “Volcker Rules”.  It’s an uphill struggle – the proposed ban on proprietary trading (i.e., excessive risk-taking by government-backed banks) is holding on by its fingernails in the Dodd bill and the prospective cap on bank size is completely missing.  But Mr. Volcker does not give up so easily – expect a firm yet polite diplomatic offensive from his side (although the extent of White House support remains unclear), including some hallmark tough public statements.  It’s all or nothing now for both Volcker and the rest of us.

The End of Gradualism?

Back in 2004, on the heels of the Fed’s tightening cycle, Ben Bernanke gave a speech in defense of “gradualism”—the idea that, under normal circumstances, economies are better served when central banks adjust their policy rates gradually, moving in a series of moderate steps in the same direction.

Should the Fed Stay in Regulation?

One of the central issues in the postcrisis effort to reform our regulatory infrastructure is who should do the regulating. The answer to some in Congress is none of the above:

“… under consideration is a consolidated bank regulator, one aide [to Alabama Senator Richard Shelby] said. The idea is supported by [Connecticut Senator Christopher] Dodd, who proposed eliminating the Office of Thrift Supervision and Office of the Comptroller of the Currency, and moving their powers, along with the bank-supervision powers of the Federal Reserve and the Federal Deposit Insurance Corp., to the new agency.

“Negotiators are still deciding how to monitor firms for systemic risk, including how to define and measure it, what authorities to give a regulator and which agency is best suited to get the power, a Shelby aide said.”

Letter to Ben Bernanke

Dear Ben,

By now you have realized that Federal Reserve policy has become highly politicized. While the media is placing you squarely in the middle of that development, I realize that the shift has been occurring since long before you were appointed Chair, and even Governor, as the Federal Reserve has found it worthwhile and expedient in the past two decades to work directly with Congress and the various Administrations on a number of key issues, ranging from housing policy to addressing financial markets hiccups to maintaining steady economic growth. Unfortunately, that era is over and the Federal Reserve will be responsible for some tough decisions.

It’s Not about Interest Rates Yet

Incoming data continue to support expectations that the Federal Reserve will hold rates at rock bottom levels for the foreseeable future – likely into 2011.  But interest rates should not be the focus of policy analysts.  The Fed will manipulate policy via the balance sheet long before they fall back to the interest rate tool.  The question is whether or not the slow growth environment is sufficient to persuade the Fed to hold the balance sheet steady or even expand the balance sheet beyond current expectations.  And there always remains the third option, favored by a minority of policymakers – withdraw the stimulus now that growth has reemerged.  At this point, I suspect the Fed will stick with the hold steady option. 

The Letter and the Spirit of Monetary Policy

If there was one major disappointment with Bernanke’s speech at the AEA meetings last weekend it was his choice to fight insular battles will equally insular arguments.

Part of the reason was tactics of course. Inane criticisms arguably deserve a commensurate response. So when you have somebody like (Stanford economist) John Taylor on a self-appointed mission to prove that his own Taylor rule can explain absolutely anything—from the Great Inflation, to the Greenspan put, to (coming soon!) life on other planets—, using the “enemy’s” own weapon to neutralize him is a cunning strategy.

No to Bernanke

Paul Krugman’s speaking notes are here. Ben Bernanke’s are here.

Bernanke’s speech is largely a defense of the Federal Reserve’s monetary policy in the past decade, and therefore of the old Greenspan Doctrine dating back to the 1996 “irrational exuberance” speech–the idea that monetary policy is not the right tool for fighting bubbles. The Fed has gotten a lot of criticism saying that cheap money earlier this decade created the housing bubble, and I think it certainly played a role.

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