Fed Bank Regulatory Powers: The Dog That Didn't Bark?
Today’s title comes from the Sherlock Holmes story "Silver Blaze." In the story, Holmes investigates the disappearance of the eponymous equine. The following dialogue inspires our title:
Detective: Is there any other point to which you would wish to draw my attention?
Holmes: To the curious incident of the dog in the night-time.
Detective: The dog did nothing in the night-time.
Holmes: That was the curious incident.
On Nov 19 the Cato Institute held its Annual Monetary Policy Conference: Lessons From The Subprime Crisis. Below is a portion of the agenda, taken from the Cato Institute’s website:
Leading experts will discuss the underlying causes of the [current crisis] and loss of confidence, particularly the policies that contributed to the subprime crisis and the reforms needed to avoid future turmoil in financial markets.
Issues to be discussed at this year’s monetary conference include:
- What responsibility does the Fed have for the subprime crisis?
- What are the limits of monetary policy?
- How can financial and monetary rules be improved to reduce moral hazard and improve financial stability?
- Can the Fed prevent asset bubbles?
Donald L. Kohn, Vice Chairman of the Board of Governors of the Federal Reserve System, delivered the conference’s keynote address.
In that address, Dr. Kohn acknowledged that the crisis is so severe that it requires a careful review to “prevent a similar situation from happening again.” Dr. Kohn had previously argued that a central bank facing a possible asset bubble would have to surmount some high hurdles before it would be justified in tightening policy beyond what the outlook for output and inflation would require, after taking into account past and projected asset price developments.
In his keynote address, Dr. Kohn asked “does that conclusion still hold?” He began by outlining the “tough conditions” that must be met if the Fed were to pursue an activist monetary policy.
- The expected improvement in future economic performance resulting from the curtailment of the bubble must be sufficiently great;
- Policymakers must be able to identify bubbles in a timely fashion with reasonable confidence; and
- A somewhat tighter monetary policy must have a high probability that it will help to check at least some of the speculative activity.
With respect to #1 (the potential gain from limiting bubbles), Dr. Kohn suggests that prior US economic resilience may have “unduly” comforted him into underestimating the difficulty of “mopping up” after the housing price bubble.
With respect to #2 (timely identification of bubbles), given the lags with which monetary policy works, and the uncertainty associated with bubble identification, Dr. Kohn remains skeptical that monetary policy could have been tightened in a timely and appropriate fashion.
With respect to #3 (the ability of interest rates to limit speculation), Dr. Kohn is doubtful, and observes that a close examination of the progress of the bubble and monetary policy does not convince him that speculation could have been limited.
Dr. Kohn then suggests that the relatively stable economic environment that has prevailed since the mid 1980’s may have contributed to a wide-spread complacency and underestimation of speculative consequences.
Dr. Kohn sums up by saying that he is “not convinced that the events of the past few years and the current crisis demonstrate that central banks should … [try] to check speculative activity through tighter monetary policy whenever they perceive a bubble forming. “
Given the scope of the Cato Conference (“Monetary Policy”), what follows may be unfair. But given the severity of the current situation, I believe it’s justified.
According to the Fed’s own Frequently Asked Questions, today’s Fed has four broad responsibilities.
Federal Reserve Responsibilities
- Conducting the nation's monetary policy by influencing money and credit conditions in the economy in pursuit of full employment and stable prices.
- Supervising and regulating banking institutions to ensure the safety and soundness of the nation's banking and financial system and to protect the credit rights of consumers.
- Maintaining the stability of the financial system and containing systemic risk that may arise in financial markets.
- Providing certain financial services to the U.S. government, to the public, to financial institutions, and to foreign official institutions, including playing a major role in operating the nation's payments systems.
Note: A slightly more detailed version of the above can also be found on page 10 of the Fed’s 146 page “Federal Reserve System: Purposes & Functions”, available on the Fed’s website.
I’d like to suggest that Dr. Kohn’s keynote address, while fine as far as it went, was too narrowly focused given both the Fed’s powers and the Cato Conference’s scope.
Dr. Kohn largely confined his discussion to the “limits of monetary policy” (item #2 on the Cato Agenda [see above]).
But consider the Fed’s own declaration [see Fed Responsibilities #2, above] of its second responsibility:
Supervising and regulating banking institutions to ensure the safety and soundness of the nation's banking and financial system and to protect the credit rights of consumers.
If monetary policy IS as limited and constrained as Dr. Kohn describes, then what happened to the Fed’s other powers & responsibilities – for bank supervision and regulation - during the run-up?
That’s the question I’d like to see answered, and I hope I won’t have to wait a year for the answer.
Disclosure: No positions.
REFERENCES [Accessed 19 Nov 2008]
D.L Kohn, Federal Reserve/Cato Institute, Monetary Policy and Asset Prices Revisited, 19 Nov 2008.
Federal Reserve System: Purposes and Functions, June 2005.
Cato Institute, 26th Annual Monetary Conference: Lessons from the Subprime Crisis, 19 Nov 2008.
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This article has 9 comments:
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Jimmy Lathrop
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269 Comments
My Website
Nov 20 07:40 AMAre you somehow suggesting that an Administration which exercised executive powers like a baseball bat for the last eight years and installed department store mannequins as financial regulators somehow were asleep at the switch?
The question which is going to be asked in a year is the Watergate questions, which is, what did they know and when did they know it.
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copperbaron
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51 Comments
Nov 20 08:28 AMThis administration has been grossly negligent in its role as a financial regulator and enforcer of laws against white collar crimes, racketeering, and abuse of the markets.
I really wish that a number of these clowns would be sent to prison, not that I expect that to happen.
The Fed has proven to be inept, deeply misguided, quite arrogant, and extremely clueless about what was going on RIGHT UNDER THEIR COLLECTIVE NOSES for the past five years - all at the same time!!
Really pathetic, if you ask me. So as a final insult to the American public, these hapless morons hold a conference so that they can give speeches to each other, assuring themselves that they did nothing wrong!
Now, that is really atrocious.
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msoori
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71 Comments
My Website
Nov 20 08:28 AM-
sheople
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69 Comments
Nov 20 09:11 AM-
Ira Artman
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17 Comments
My Website
Nov 20 10:24 AMSet new standard for Fed policy:
Are they sleeping with the goats? If not, why not? They should be!
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paulsjj
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15 Comments
My Website
Nov 20 12:05 PM-
Ira Artman
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17 Comments
My Website
Nov 20 09:05 PMAt very end of Dr Kohn's remarks believe is a paragraph referring to structure and lvrg, etc. which felt very unnatural like something someone made him put in, but that he didn't want to talk about it. take a look at his 19 nov speech and work through it think youll see what I mean
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No Sympathy
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6 Comments
Nov 20 09:57 PMIn attending 20 years of bank reviews, the Bank where I was a director, was never criticized for any mortgage loan we made... only the ones we did not make. The "credit rights" of the customer is incompatible with the "safely and soundness" of banks. Since no one can serve two masters, the wishes of the master in DC who carried the bigger stick was served. When ever their was a conflict between safety and soundness and CRA (Community Reinvestment Act) CRA won. This was not the fault of the cops on the beat, their hands were tied by policy in DC. (read Congress).
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You're Kidding
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39 Comments
Nov 21 03:24 AMsamjohn wrote:
When ever their was a conflict between safety
and soundness and CRA (Community Reinvestment Act) CRA won. This
was not the fault of the cops on the beat, their hands were tied
by policy in DC. (read Congress).
----------------------...
I keep hearing about the CRA like it is some big deal that is responsible for the the housing meltdown. Yet, from one source I read (can't remember where) it said that only 17% of lenders fell under CRA guidelines, and only one of the top 25 lenders did.
So I went to Wikipedia
en.wikipedia.org/wiki/...
and got this:
Some legal and financial experts note that CRA regulated loans tend to be safe and profitable, and that subprime excesses came mainly from institutions not regulated by the CRA. In the February 2008 House hearing, law professor Michael S. Barr, a Treasury Department official under President Clinton,[66][36] stated that a Federal Reserve survey showed that affected institutions considered CRA loans profitable and not overly risky. He noted that approximately 50% of the subprime loans were made by independent mortgage companies that were not regulated by the CRA. Another 25% to 30% came from only partially CRA regulated bank subsidiaries and affiliates. He stated that institutions fully regulated by CRA made "perhaps" one in four sub-prime loans. Referring to CRA and abuses in the subprime market, Michael Barr stated that in his judgment "the worst and most widespread abuses occurred in the institutions with the least federal oversight".[67] According to Janet L. Yellen, President of the Federal Reserve Bank of San Francisco, independent mortgage companies made "high-priced loans" at more than twice the rate of the banks and thrifts; most CRA loans were responsibly made, and were not the higher-priced loans that have contributed to the current crisis.[68]
Based on what I have seen, most people who mention the CRA want to use it as a way to put responsibility for the housing bubble on poor people and the government. But they never mention any statistics to back that belief up.
There is more info and history on the CRA at the above source for those of you who consider factual statistics more important than empty generalizations when you try and make a point.